Quarterly Report (10-q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

_______________________________

FORM 10-Q

(Mark One)

X Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2015

OR

Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from ____ to ____

Commission file number: 000-28238

APPLIED VISUAL SCIENCES, INC.

(Exact name of registrant as specified in its charter)


Delaware		54-1521616
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

525K East Market Street, # 116, Leesburg, Virginia 20176

(Address of principal executive offices and zip code)

(703) 539-6190

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ü No __

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ü No __

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [ ] Smaller reporting company [ü]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes __ No ü

At August 19, 2015, the Registrant had 107,228,612 shares of Common Stock, $0.001 par value, outstanding.

NOTE REGARDING FORWARD-LOOKING STATEMENTS

Our disclosure and analysis in this Report contains forward-looking statements which provide our current expectations or forecasts of future events. Forward-looking statements in this Report include, without limitation:

·

information concerning possible or assumed future results of operations, trends in financial results and business plans, including those related to earnings, earnings growth, revenue and revenue growth;

·

statements about the level of our costs and operating expenses relative to our revenues, and about the expected composition of our revenues;

·

statements about expected future sales trends for our products;

·

statements about our future capital requirements and the sufficiency of our cash, cash equivalents, and available bank borrowings to meet these requirements;

·

information about the anticipated release dates of new products;

·

other statements about our plans, objectives, expectations and intentions;

·

and other statements that are not historical fact.

Forward-looking statements generally can be identified by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “intends, “plans,” “should,” “seeks,” “pro forma,” “anticipates,” “estimates,” “continues,” or other variations thereof (including their use in the negative), or by discussions of strategies, plans or intentions. Such statements include but are not limited to statements under Part I, Item 1A - Risk Factors of our Form 10-K for the year ended December 31, 2014, Part I, Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations in this Report, and elsewhere in this Report. A number of factors could cause results to differ materially from those anticipated by such forward-looking statements, including those discussed under Part II, Item 1A - Risk Factors of this Report. The absence of these words does not necessarily mean that a statement is not forward-looking. Forward-looking statements are subject to known and unknown risks and uncertainties and are based on potentially inaccurate assumptions that could cause actual results to differ materially from those expected or implied by the forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including factors described in Part I, Item 1A - Risk Factors of our Form 10-K for the year ended December 31, 2014, and Part II, Item 1A – Risk Factors of this Report. You should carefully consider the factors described in Part I, Item 1A - Risk Factors of our Form 10-K for the year ended December 31, 2014, and Part II, Item 1A – Risk Factors of this Report in evaluating our forward-looking statements.

You should not unduly rely on these forward-looking statements, which speak only as of the date of this Report. We undertake no obligation to publicly revise any forward-looking statement to reflect circumstances or events after the date of this Report, or to reflect the occurrence of unanticipated events. You should, however, review the factors and risks we describe in the reports we file from time to time with the Securities and Exchange Commission (“SEC”).

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APPLIED VISUAL SCIENCES, INC.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

4

ITEM 1. FINANCIAL STATEMENTS

4

CONDENSED CONSOLIDATED BALANCE SHEETS

4

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

5

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

7

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 21

CONSOLIDATED RESULTS OF OPERATIONS

28

LIQUIDITY AND CAPITAL RESOURCES

31

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

39

ITEM 4. CONTROLS AND PROCEDURES

39

PART II. OTHER INFORMATION

39

ITEM 1. LEGAL PROCEEDINGS

39

ITEM 1A. RISK FACTORS

39

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

41

ITEM 3. DEFAULT UNDER OUR SERIES A DEBENTURES

41

ITEM 5. OTHER INFORMATION

42

ITEM 6. INDEX TO EXHIBITS

42

SIGNATURES

43

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CONDENSED CONSOLIDATED BALANCE SHEETS


APPLIED VISUAL SCIENCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

		June 30	December 31
		2015	2014
		(Unaudited)
ASSETS
Current Assets
	Cash	$ 18,484	$ 33,961
	Prepaid expenses	1,824	2,324
	Total current assets	20,308	36,285

Fixed Assets, net		50,952	44,329

Other Assets
	Intangible assets, net	283,360	291,725
	Total assets	$ 354,620	$ 372,339

LIABILITIES AND STOCKHOLDERS' (DEFICIT)
Current Liabilities
	Accounts payable	$ 1,826,743	$ 1,792,192
	Accrued wages and related	9,126,140	8,792,108
	Other accrued liabilities	290,478	242,404
	Notes payable and advances, related parties	80,500	80,500
	Notes payable, net of discount	807,500	807,500
	Convertible debentures	2,025,846	2,025,846
	Derivative liabilities	67,528	202,585
	Total current liabilities	14,224,735	13,943,135

Stockholders' (Deficit)
	Convertible preferred stock, $0.20 par value; authorized 1,000,000 shares
	Shares issued and outstanding at June 30, 2015 - none
	Shares issued and outstanding at December 31, 2014 - none	-	-
	Common stock, $0.001 par value; authorized 200,000,000 shares
	Shares issued and outstanding at June 30, 2015 - 106,728,612
	Shares issued and outstanding at December 31, 2014 - 104,728,612	106,729	104,729
	Additional paid-in capital	83,051,348	82,993,348
	Accumulated comprehensive income	63,354	63,354
	Deficit accumulated	(97,091,546)	(96,732,227)
	Total stockholders' (deficit)	(13,870,115)	(13,570,796)
	Total liabilities and stockholders' (deficit)	$ 354,620	$ 372,339

See notes to condensed consolidated financial statements.

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CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME


APPLIED VISUAL SCIENCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(Unaudited)

	Three Months Ended June 30		Six Months Ended June 30
	2015	2014	2015	2014

Net revenues	$ -	$ -	$ -	$ -

Cost of sales	-	-	-	-

Gross profit	-	-	-	-

Selling, general and administrative expense	226,685	232,234	446,302	515,738

Operating loss	(226,685)	(232,234)	(446,302)	(515,738)

Other income (expense)
Interest expense	(29,629)	(24,913)	(48,074)	(43,358)
Debt discount amortization	-	(5,537)	-	(15,541)
Reevaluation of derivative liabilities	67,528	135,056	135,057	270,113
Other income	37,899	104,606	86,983	211,214

Net loss before income taxes	(188,786)	(127,628)	(359,319)	(304,524)
Provision for income taxes	-	-	-	-

Net loss	$ (188,786)	$ (127,628)	$ (359,319)	$ (304,524)

Net loss per common share
Basic	$ (0.00)	$ (0.00)	$ (0.00)	$ (0.00)

Weighted average common shares outstanding
Basic	106,530,810	103,138,601	105,634,689	102,948,463

Comprehensive income
Comprehensive income - beginning of period	$ 63,354	$ 63,354	$ 63,354	$ 63,354
Cumulative translation adjustments	-	-	-	-

Comprehensive income - end of period	$ 63,354	$ 63,354	$ 63,354	$ 63,354

See notes to condensed consolidated financial statements.

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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


APPLIED VISUAL SCIENCES, INC. AND SUBSIDIARIES
CONSENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

	Six Months Ended June 30
	2015	2014
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss	$ (359,319)	$ (304,524)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	27,257	29,395
Amortization of debt discounts	-	15,541
Stock-based compensation expense	-	10,279
Revaluation derivative instrument (income)	(135,057)	(270,113)
Changes in operating assets and liabilities:
Decrease in prepaid expenses	500	(6,983)
Increase in accounts payable	34,552	42,877
Increase in accrued wages and related	334,032	416,815
Increase in other accrued liabilities	48,074	43,358
Net cash flows used in operating activities	(49,961)	(23,355)

CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of equipment	(21,816)	-
Investment in patents	(3,700)	-
Net cash used in investing activities	(25,516)	-

CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from exercise of stock warrants	60,000	-
Proceeds from short-term notes payable, net	-	33,000
Net cash flows provided by financing activities	60,000	33,000

Net increase (decrease) in cash	(15,477)	9,645
Cash at beginning of the period	33,961	1,108
Cash at end of the period	$ 18,484	$ 10,753

Supplemental disclosure of cash flow information:
Cash items paid during the period:
Interest expense	$ -	$ -
Income taxes	-	-
Noncash items during the period:
Conversion of accrued wages for exercise of employee stock options	$ -	$ 23,880

See notes to condensed consolidated financial statements.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(1)

Description of Business

Overview

Applied Visual Sciences, Inc. was incorporated under the name Guardian Technologies International, Inc., in the Commonwealth of Virginia in 1989 and reincorporated in State of Delaware in February 1996. We changed our name to Applied Visual Sciences, Inc., on July 9, 2010. The Company, previously an operating stage company, became a development stage company on April 1, 2012, the date of inception as a development stage company for financial reporting. Applied Visual Sciences, Inc. and its subsidiaries are collectively referred to herein as the “Company,” “Applied Visual Sciences, Inc.,” “Applied Visual,” “us,” “we,” or “our.”

Applied Visual Sciences is a software technology company that designs and develops computer-vision detection solutions based on image processing science for delivery to its target markets, aviation/homeland security and healthcare. Our two product lines are offered through our two operating subsidiaries as follows: Guardian Technologies International, Inc. for aviation/homeland security products, Signature Mapping Medical Sciences, Inc., for healthcare, and Instasis Imaging, Inc., a wholly owned subsidiary of Signature Mapping Medical Sciences, Inc., for the development, marketing, and sales of a suite of computer-vision applications for the automated detection of breast cancer. We may engage in one or more acquisitions of businesses that are complementary, and may form wholly-owned subsidiaries to operate within defined vertical markets products.

The Company utilizes imaging technologies and analytics to create integrated information management technology products and services that address critical problems experienced by corporations and governmental agencies in healthcare and homeland security. Each product and service can improve the quality and response time of decision-making, organizational productivity, and efficiency within the enterprise. Our product suite integrates, streamlines, and distributes business and clinical information and images across the enterprise.

Our Business Strategy

Our strategic vision is to position our core technology as the de facto standard for digital image analysis, knowledge extraction, and detection. Our strategy is based upon the following principal objectives:

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Maintain product development and sales/marketing focus on large, underserved, and rapidly growing markets with a demonstrated need for intelligent computer-vision detection.

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Leverage Applied Visual Sciences, Inc.’s technology, experienced management team, research and development infrastructure.

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Focus our talents on solving highly challenging information problems associated with digital imaging analysis.

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Establish an international market presence through the development of a significant OEM/Reseller network.

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Build and maintain a strong balance sheet to ensure the availability of capital for product development, acquisitions, and growth.

·

Seek to broaden our investment appeal to large institutions.

To achieve our strategic vision, we are aware of the need to exercise the financial and operational discipline necessary to achieve the proper blend of resources, products and strategic partnerships. These efforts can accelerate our ability to develop, deploy and service a broad range of intelligent computer-vision detection solutions directly to our target markets and indirectly through OEM/value added reseller (“VAR”) partners. During 2014, we continued implementing changes across the spectrum of our business. We conducted independent international clinical trials and scientific validation of our TBDx™ tuberculosis detection technology.

We may engage in one or more acquisitions of businesses that are complementary, and may form wholly-owned subsidiaries to operate within defined vertical markets.

Our Core Technology

Our core technology is an “intelligent computer-vision detection” (“3i™”) engine that is capable of extracting embedded knowledge from digital images, and has the capacity to analyze and detect image anomalies. The technology is not limited by type of digital format. It can be deployed across divergent digital sources such as still images, x-ray images, video and hyper-spectral imagery. To date, the technology has been tested in the area of threat detection for baggage scanning at airports, for bomb squad applications and the detection of tuberculosis by analyzing digital images of stained sputum slides captured through a photo microscopy system. Varying degrees of research and development have been conducted in the areas of detection for cargo scanning, people scanning, military target acquisition in a hyper-spectral environment, satellite remote sensing ground surveys and mammography CAD products

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and radiologists’ diagnostic imaging tools, and while product development in these areas is ongoing, there can be no assurance that we will successfully develop product offerings in these areas.

We are currently focused on providing software technology solutions and services in two primary markets - aviation/homeland security with PinPoint™ and healthcare technology with Signature Mapping™ solutions. However, as new or enhanced solutions are developed, we expect to expand into other markets such as military and defense utilizing hyper-spectral technology, and imaging diagnostics for the medical industry.

(2)

Basis of Presentation

The Company, previously an operating stage company, became a development stage company on April 1, 2012. A development stage company, as defined by ASC-915-10 “Accounting and Reporting by Development Stage Enterprise”, is an entity that devotes substantially all of its efforts to establish a business and either of the following conditions exists: 1) the principal operations have not commenced, or 2) the principal operations have commenced, but there has been no significant revenue therefrom. As noted herein, the Company has elected early adoption of ASU 2014-10 whereby the Company has removed all amounts and disclosures related to the development stage.

The unaudited condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The accompanying unaudited condensed consolidated financial statements do not include complete footnotes and financial statement presentations. As a result, these unaudited condensed consolidated financial statements should be read along with the audited consolidated financial statements and notes thereto for the year ended December 31, 2014, included in our 2014 Annual Report on Form 10-K. In our opinion, the unaudited condensed consolidated financial statements reflect all adjustments, including normal recurring adjustments, necessary for a fair presentation of the financial position, results of operations and cash flows for those periods presented. The preparation of financial statements in conformity with United States (U.S.) generally accepted accounting principles requires management to make estimates and assumptions that affect reported assets, liabilities, revenues and expenses, as well as disclosure of contingent assets and liabilities. Actual results could differ from those estimates and assumptions. Moreover, the results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for the entire year.

The Company maintains a website at www.appliedvs.com, which makes available free of charge our recent annual report and other filings with the SEC. In addition to its website, the Company also disseminates material non-public information on Facebook at https://www.facebook.com/appliedvs and on Twitter at https://mobile.twitter.com/appliedvs.

These unaudited condensed consolidated financial statements have been prepared assuming that the Company will continue as a going concern and, accordingly, do not include any adjustments that might result from the outcome of this uncertainty. Our independent registered public accounting firm’s reports on the consolidated financial statements included in our annual report on Form 10-K for the year ended December 31, 2014, contains an explanatory paragraph wherein it expressed an opinion that there is substantial doubt about our ability to continue as a going concern. Accordingly, careful consideration of such opinion should be given in determining whether to continue or become our stockholder.

Summary of Significant Accounting Policies

Development Stage Company

The Company, previously an operating stage company, became a development stage company on April 1, 2012. A development stage company, as defined by ASC-915-10 “Accounting and Reporting by Development Stage Enterprise”, is an entity that devotes substantially all of its efforts to establish a business and either of the following conditions exists: 1) the principal operations have not commenced, or 2) the principal operations have commenced, but there has been no significant revenue therefrom. The Company has elected early adoption of ASU 2014-10 whereby the Company has removed all amounts and disclosures related to the development stage.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries, Guardian Technologies International, Inc., Signature Mapping Medical Sciences, Inc., Instasis Imaging, Inc., RJL Marketing Services, Guardian Healthcare Systems UK, Ltd., and Wise Systems Ltd., in which it has the controlling interest. Subsidiaries acquired are consolidated from the date of acquisition. All significant intercompany balances and transactions have been eliminated. Certain amounts in the consolidated financial statements of prior periods have been reclassified to conform to current period presentation.

Estimates

The preparation of these consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements. Changes in these estimates and assumptions may have a material impact on the consolidated financial statements. Certain estimates and assumptions are particularly sensitive to change in the near term, and include estimates of net realizable value for long-lived and

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intangible assets, the valuation allowance for deferred tax assets and the assumptions used for measuring stock-based payments and derivative liabilities.

The Company reviews the terms of convertible debt and equity securities for indications requiring bifurcation, and separate accounting, for the derivative liability feature. Under guidelines of ASC 815-40, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock,” public companies that are required, or that could be required, to deliver shares of common stock as part of a physical settlement or a net-share settlement, under a freestanding financial instrument, are required to initially measure the contract at fair value (or allocate on a fair value basis if issued as part of a debt financing), and report the value in permanent equity. However, in certain circumstances (e.g. the company could not ascertain whether sufficient authorized shares exist to settle the contract), permanent equity classification should be reassessed. The classification of the contract as permanent equity should be reassessed at each balance sheet date and, if necessary, reclassified as a liability on the date of the event causing the reclassification. If a reclassification occurs from permanent equity to a liability, the fair value of the financial instrument should be removed from permanent equity as an adjustment to stockholders’ deficit. Any portion of the contract that could be net-share settled as of the balance sheet date would remain classified in permanent equity. Subsequent to the initial reclassification event, changes in fair value of the instrument are charged to expense until the conditions giving rise to the reclassification are resolved. When a company has more than one contract subject to reclassification, it must determine a method of reclassification that is systematic, rational, and consistently applied. The Company adopted a reclassification policy that reclassifies contracts with the latest inception date first. To the extent that changes in fair value of equity instruments relates to financings since November 8, 2006 (the date of first closing under the debenture financing with reset provisions that made the number of potentially issuable shares indeterminable), the increase or decrease in the fair value of the warrants is charged or credited to interest expense. To the extent the equity instruments relate to other transactions (e.g. consulting expense), the increases or decreases are charged or credited based on the nature of the transaction. The number of additional shares potentially issuable under the November 8, 2006, outstanding convertible debentures and related outstanding warrants and other subsequent warrants issued was determinable as of the debentures’ final milestone reset date on May 20, 2008, and, therefore, the outstanding fair value of the warrants issued to the debenture holders, other subsequent warrants issued through May 20, 2008, and the warrants’ related beneficial conversion feature were reclassified as stockholders’ deficit in accordance with currently effective generally accepted accounting principles.

Reclassifications

Certain reclassifications of previously reported amounts have been made to conform to the current period presentation. These classifications had no effect on the previously reported net loss.

Segment Information

ASC 280-10, “Disclosures about Segments of an Enterprise and Related Information,” establishes standards for the manner in which public companies report information about operating segments in annual and interim financial statements. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. The method for determining what information to report is based on the way management organizes the operating segments within the Company for making operating decisions and assessing financial performance. The Company’s chief operating decision-maker is considered to be the Company’s chief executive officer (“CEO”). The CEO reviews financial information presented on an entity level basis accompanied by disaggregated information about revenues by product type and certain information about geographic regions for purposes of making operating decisions and assessing financial performance. The entity level financial information is identical to the information presented in the accompanying consolidated statements of operations.

The Company has two groups of products and services - Security (PinPoint™) and Healthcare (Signature Mapping™ Medical Computer Aided Detection (“Medical CAD”)). The Company has determined that as a result of no revenue generated for the six months ended June 30, 2015, and the same period last year, we operate under one business unit in The America’s, and have pursued one product line, Healthcare’s Tuberculosis Detection (“TBDx™”) software in South Africa, India, Nigeria, Peru, and Vietnam.

Stock-Based Compensation

On January 1, 2006, the Company adopted the provisions of ASC 718-10, which requires recognition of stock-based compensation expense for all share-based payments based on fair value. Prior to January 1, 2006, the Company measured compensation expense for its employee stock based compensation plans using the intrinsic value method. Under ASC 718-10, when the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. The Company applied the disclosure provisions of ASC 718-10 as if the fair value-based method had been applied in measuring compensation expense for those years. ASC 718-10 required that the Company provide pro forma information regarding net earnings and net earnings per common share as if compensation expense for its employee stock-based awards had been determined in accordance with the fair value method prescribed therein. The Company’s estimated forfeiture rates are based on its historical experience within separate groups of employees. In accordance with ASC 718-10, the Company recognized total stock-based compensation expense for employees and non-employee members of the Board of Directors for the six months ended June 30, 2015 and 2014, of $0, and $10,279, respectively.

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ASC 718-10, “Share-Based Payment” defines fair value-based methods of accounting for stock options and other equity instruments. The Company has adopted the method, which measures compensation costs based on the estimated fair value of the award and recognizes that cost over the service period. ASC 505-50, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods, or Services” (“ASC 505-50”), establishes the measurement principles for transactions in which equity instruments are issued in exchange for the receipt of goods or services. The Company has relied upon the guidance provided under ASC 505-50 to determine the measurement date and the fair value re-measurement principles to be applied. Based on these findings, the Company determined that the unamortized portion of the stock compensation should be re-measured on each interim reporting date and proportionately amortized to stock-based compensation expense for the succeeding interim reporting period until goods are received or services are performed. The Company recognizes compensation costs, net of an estimated forfeiture rate, on a pro rata basis over the requisite service period of each vesting tranche of each award. The Company considers voluntary termination behavior as well as trends of actual option forfeitures when estimating the forfeiture rate. Total stock-based compensation expense for consultants during the six months ended June 30, 2015, and 2014 was $0, and $0, respectively.

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are not transferable. The fair value of each option granted was estimated on the date of grant using the Black-Scholes Merton option pricing model (Black-Scholes model) with the following weighted-average assumptions.


Black-Scholes Model Assumptions		2015	2014
Risk-free interest rate (1)		1.84%	2.48%
Expected volatility (2)		206.5%	184.8%
Dividend yield (3)		0.0%	0.0%
Expected life (4)		6.5 years	7.2 years

(1)	The risk-free interest rate is based on US Treasury debt securities with maturities similar to the expected term of the option.
(2)	Expected volatility is based on historical volatility of the Company*s stock factoring in daily share price observations.
(3)	No cash dividends have been declared on the Companys common stock since the Companys inception, and the Company currently does not anticipate paying cash dividends over the expected term of the option.
(3)
(4)	The expected term of stock option awards granted is derived from historical exercise experience under the Company*s stock option plan and represents the period of time that stock option awards granted are expected to be outstanding. The expected term assumption incorporates the contractual term of an option grant, which is usually ten years, as well as the vesting period of an award, which is generally pro rata vesting over two years.

The Amended and Restated 2003 Stock Incentive Plan

The Board of Directors adopted the 2003 Stock Incentive Plan on August 29, 2003, and terminated on August 29, 2013. Therefore, no shares of common stock are available for future awards. The termination of the plan does not affect the outstanding options granted without the consent of the optionee. As of June 30, 2015, the Company has reserved under the 2003 plan 22,056,992 shares to be issued upon exercise of outstanding options granted to all employees, including its named executives.

The Board of Directors amended and restated the plan on December 2, 2003. The Amended and Restated 2003 Stock Incentive Plan (“2003 Plan”) was approved by the shareholders on February 13, 2004, pursuant to which it grants stock-based compensation in the form of options, which could result in the issuance of up to an aggregate of 30,000,000 shares of the Company’s common stock. The aggregate number of shares and the number of shares in an award (as well as the option price) may be adjusted if the outstanding shares of the Company are increased, decreased or exchanged through merger or other stock transaction. The Plan provides for options which qualify as Incentive Stock Options under Section 422 of the Internal Revenue Code of 1986, as well as the issuance of Non-Qualified Options, which do not so qualify. Pursuant to the terms of the 2003 Plan, the Company, as determined by the Board of Directors or a committee appointed by the Board, may grant Non-Qualified Stock Options (“NQSOs”) to its executive officers, non-employee directors, or consultants of the Company and its subsidiaries at any time, and from time to time. The 2003 Plan also provided for Incentive Stock Options (“ISOs”) to be granted to any officer or other employee of the Company or its subsidiaries at any time, and from time to time, as determined by the Compensation Committee. Such stock options granted allow a grantee to purchase a fixed number of shares of the Company’s common stock at a fixed exercise price not be less than the quoted market price (or 110% thereof for Incentive Stock Options issued to a holder of 10% or greater beneficial ownership) of the shares on the date granted. The options may vest on a single date or over a period of time, but normally they do not vest unless the grantee is still employed by, or a director of, the Company on the vesting date. Generally for all employees, the options vest 50% after the first year from the date of grant and the remaining 50% after the second year from the date of grant. Stock options granted to independent board of directors vest 100% after the service period, which generally is one year from the date of grant.

Factors considered in granting stock options included: (i) the general policy during the past five, and in the foreseeable future, of not increasing base salaries of all employees, (ii) the performance of employees, (iii) the employees’ increasing responsibilities in a dynamic, and shrinking organization, and (iv) the accomplishments achieved by the Company during the prior year. The 2003 Plan has been the principal method for our employees and executive officers to acquire equity interests in the Company. We believe that the annual aggregate value of these awards should be set near competitive median levels for comparable companies. We may provide a greater portion of total compensation to our executives and employees through stock options given the general policy of not

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increasing base salaries in the foreseeable future. Our Compensation Committee administers the 2003 Plan based on the above factors, and considers management’s recommendation and discussions with the Committee. There were no stock options granted to employees during the six months ended June 30, 2015, as well as no stock options granted to new employees during the same period as there were no new employees hired.

Options granted under the Plan must be evidenced by a stock option agreement in a form consistent with the provisions of the 2003 Plan. Each option shall expire on the earliest of (a) ten (10) years from the date it is granted, (b) sixty (60) days after the optionee dies or becomes disabled, (c) immediately upon the optionee's termination of employment or service or cessation of Board service, whichever is applicable, or (d) such date as the Committee shall determine, as set forth in the relevant option agreement; provided, however, that no ISO which is granted to an optionee who, at the time such option is granted, owns stock possessing more than ten (10) percent of the total combined voting power of all classes of stock of the Company or any of its subsidiaries, shall be exercisable after the expiration of five (5) years from the date such option is granted.

To exercise an option, the 2003 Plan participant, in accordance with the relevant option agreement, must provide the Company a written notice setting forth the number of options being exercised and their underlying shares, and tender an amount equal to the total exercise value of the options being exercised. The right to purchase shares is cumulative so that once the right to purchase any shares has vested; those shares or any portion of those shares may be purchased at any time thereafter until the expiration or termination of the option. ISOs and NQSOs that are not exercised in accordance with the terms and provisions of the stock option agreement, or as amended, will expire as to any then unexercised portion. Stock options that expire, are cancelled, or forfeited will again become available for issuance under the 2003 Plan as described below. The aggregate number of shares and the number of shares in an award (as well as the option price) may be adjusted if the outstanding shares of the Company are increased, decreased or exchanged through merger or other stock transaction. The shares issued by the Company under the 2003 Plan may be either treasury shares or authorized but unissued shares as the Company’s board of directors or the Compensation Committee may determine from time to time. Except as specifically provided in an option agreement, options granted under the 2003 Plan may not be sold, pledged, transferred or assigned in any way, except by will or by the laws of descent and distribution, and during the lifetime of a participant to whom the ISOs is granted, and the ISOs may only be exercised by the participant.

Stock Options Exercised under the 2003 Plan

There were no stock options exercised during the six months ending June 30, 2015.

Summary of stock option activity under the 2003 Plan for the six months ended June 30, 2015 issued to employees, non-employee members of the Board of Directors and consultants is as follows:


Fiscal Year and Activity	Weighted- Average Exercise Price	Number of Options



Outstanding December 31, 2014	$ 0.14	22,056,992

Fiscal 2015 activity
Granted	-	-
Exercised	-	-
Cancelled	-	-
Outstanding June 30, 2015	0.14	22,056,992

Reserved for future issuance at June 30, 2015 (the 2003 Plan expired on August 29, 2013)		-

The following table summarizes additional information about the 2003 Plan stock options outstanding at June 30, 2015:

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Issued and Outstanding				Exercisable
Type of Option and Range of Exercise Prices	Number of Options	Weighted-Average Remaining Contractual Life (Yrs)	Weighted-Average Exercise Price	Number of Options	Weighted-Average Price
Nonqualified Stock Options $0.30 (1) (4)	25,000	0.2	0.30	25,000	0.30
Incentive Stock Options $0.15 - $4.05 (2) (4)	649,300	2.3	0.98	649,300	0.98
Incentive Stock Options $0.15 - $0.30 (3) (4)	21,382,692	6.1	0.11	21,382,692	0.11
Total	22,056,992	6.0	$ 0.14	22,056,992	$ 0.14

(1) Issued to directors below fair value and during the period of February 2004 to September 2005.
(2) Issued to consultants at fair value.
(3) Issued to directors and employees at fair value, or above fair value for those individuals with greater than 10% beneficial ownership.
(4) The exercise price reflects the repricing of stock options as approved by the Compensation Committee on April 24, 2010, and subsequent issuances at fair value on the date of grant.

The 2009 Stock Compensation Plan

On June 4, 2009, the Board of Directors adopted the 2009 Stock Compensation Plan (“2009 Plan) which provides for the grant or issuance of up to an aggregate of 20,000,000 shares of the Company’s common stock pursuant to non-qualified stock options (“NQSOs”), restricted stock awards (“RSAs”), restricted stock rights (“RSRs”), or common stock awards (“Common Stock Awards”) (a NQSO, RSA, RSR or Common Stock Award, individually, an “Award;” collectively, “Awards”). Our Board of Directors has delegated its authority to administer the 2009 Plan to the Compensation Committee. The exercise price of NQSOs may not be less than 100% of the fair market value of the stock on the date of the option grant, and may only be exercised at such times as may be specified by the Committee and provided for in an award agreement, but may not be exercised after ten years from the date on which it was granted. RSAs and RSRs consist of a specified number of shares of the Company’s Common Stock that are, or may be, subject to restrictions on transfer, conditions of forfeiture, and any other terms and conditions for periods determined by the Committee. Generally, unless the Committee determines otherwise, once the restricted stock vests, the shares of Common Stock specified in the Award will be free of restriction, subject to any applicable lock up period. Prior to the termination of the restrictions, under a RSA (but not a RSR), a participant may vote and receive dividends on the restricted stock unless the Committee determines otherwise, but may not sell or otherwise transfer the shares. Common Stock Awards under the plan may be issued free of restriction and may vest immediately; however, the Committee may impose vesting and other restrictions related to the grant of such common stock Awards. Compensation expense for these Awards is recognized over the period they vest, although generally Common Stock Awards vest immediately, while the RSAs, RSRs and NQSOs will have a vesting period.

The purpose of the 2009 Plan is to foster our success and the success of our subsidiaries and affiliates by providing incentives to employees, directors, officers and consultants to promote our long-term financial success. The Plan complements our 2003 Amended and Restated Stock Incentive Plan (the “2003 Plan”) and provides greater flexibility to us in that it permits us to compensate and award employees, directors, officers and consultants through the issuance of certain options, RSAs, RSRs, and stock awards in addition, or as an alternative, to the incentive and non-qualified stock options that may be awarded under the 2003 Plan. The 2009 Plan terminates on June 4, 2019, and no award may be made after that date, however, awards made before that date may extend beyond that date. If an award under the 2009 Plan is cancelled, expires, forfeited, settled in cash or otherwise terminates without being exercised in full, the shares of common stock not acquired pursuant to the award will again become available for issuance under the 2009 Plan. The Board may amend, terminate, or modify the 2009 Plan at any time, without shareholder approval, unless required by the Internal Revenue Code of 1986, pursuant to Section 16 under the Securities Exchange Act of 1934, as amended, or by any national securities exchange or system on which our common stock is then listed or reported, or by any regulatory body. Subject to the provisions of the 2009 Plan, the Compensation Committee has the power to:

·

Prescribe, amend, and rescind rules and regulations relating to the 2009 Plan and to define terms not otherwise defined therein;

·

Determine which persons are eligible to participate, to which of such participants, if any, awards shall be granted, and the timing of any such awards;

·

Grant awards to participants and determine the terms and conditions thereof, including the number of shares subject to awards and the exercise or purchase price of such shares and the circumstances under which awards become exercisable or vested or are forfeited or expire;

·

Establish any performance goals or other conditions applicable to the grant, issuance, exercisability, vesting and/or ability to retain any award;

·

Prescribe and amend the terms of the agreements or other communications evidencing awards made under the 2009 Plan (which need not be identical) and the terms or form of any document or notice required to be delivered to us by participants under the 2009 Plan;

·

Determine the appropriate adjustment, if any, required as a result of any reorganization, reclassification, combination of shares, stock split, reverse stock split, spin-off or dividend (other than regular, quarterly cash

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dividends), or other changes in the number or kind of outstanding shares or any stock or other securities into which such shares shall have been exchanged;

·

Interpret and construe the 2009 Plan, any rules and regulations under the 2009 Plan and the terms and conditions of any award granted thereunder, and to make exceptions to any such provisions in good faith and for the benefit of the Company; and

·

Make all other determinations deemed necessary or advisable for the administration of the 2009 Plan.

Unless the Board expressly provides otherwise prior to a change of control or in an award agreement, in the event of a change of control of the Company, all outstanding options under the 2009 Plan vest and become exercisable on the date immediately before the change of control and all restrictions under RSAs and RSRs shall lapse or be deemed satisfied on the date immediately prior to the change of control. A change of control is deemed to have occurred upon the occurrence of one of the following events: (i) any person or group of persons becomes the beneficial owner of shares of the Company to which 50% or more of the total number of votes for the election of directors may be cast; (ii) as a result of a cash tender offer, exchange offer, merger or other business combination, sale of assets or contested election, persons who were directors immediately prior to the event cease to constitute a majority of the board; (iii) stockholders approve an agreement providing either that the Company will cease to be an independent publicly owned corporation or for sale or other disposition of all or substantially all the assets of the Company; or (iv) a tender offer or exchange offer is made for shares of our common stock (other than one made by us) and shares of common stock are acquired.

The Compensation Committee determines all awards to non-employee directors and such awards are not subject to management’s discretion. From time to time, the committee will set the amount and the type of award that will be granted to non-employee directors on a periodic, nondiscriminatory basis, including pursuant to any plan adopted by the Compensation Committee or Board for the compensation of non-employee directors. The committee may set additional awards to be granted to non-employee directors also on a periodic, nondiscriminatory basis based on one or more of the following criteria: (i) service as the chair of a Board committee; (ii) service as chairman of the Board; (iii) the number or type of Board committees on which a director serves; or (iv) the first selection or appointment of an individual to the Board.

Non-qualified stock options may be granted pursuant to non-qualified stock option award agreements and certificates adopted by the Board, as amended by the Compensation Committee. The Compensation Committee determines the terms of each stock option granted under the 2009 Plan, including the number of shares covered by an option, exercise price and means of payment, the vesting and exercisability of the option, and restrictions on transfer and the term. The exercise price of an option granted under the Plan may not be less than the fair market value on the date of option grant and may only be exercised at such times as may be specified by the Committee and provided for in an award agreement. The options expire on the earliest of ten years after the date of grant, 90 days after the death or disability of the recipient, immediately upon termination of employment or service other than by death or disability, or such date as the Compensation Committee determines. The Compensation Committee, in its sole discretion, may change by agreement the post-termination rights of a recipient, including accelerating the date or dates on which the option becomes vested and is exercisable following termination of employment or service, or extend the period. Options granted under the plan may be exercised by delivering cash, a cashless exercise, or by delivering to us the proceeds of shares of our common stock issuable under an option. Compensation expense for non-qualified stock options is recognized over the period they vest.

An award of restricted stock consists of a specified number of shares of our common stock that are, or may be, subject to restrictions, forfeiture conditions, and any other terms and conditions for periods determined by the Committee. The Compensation Committee has discretion to determine the terms of any award of restricted stock, including the number of shares subject to the award, and the minimum period over which the award may vest, and the acceleration of any vesting in the event of death, disability or change of control. RSAs are not transferable or assignable unless provided otherwise by the Compensation Committee with respect to certain specified family-related transfers. Unless the Committee determines otherwise, once the restricted stock vests, the shares of common stock specified in the Award will be free of restriction, subject to any applicable lock up period. Prior to the termination of the restrictions under a RSA, a participant may vote and receive dividends on the restricted stock unless the Committee determines otherwise, but may not sell or otherwise transfer the shares until such time as the restrictions of the award have been satisfied. Compensation expense for restricted stock awards is recognized over the period they vest.

An award of restricted stock rights entitles a participant to receive a specified number of shares of our common stock that are, or may be, subject to restrictions, forfeiture conditions, and any other terms and conditions for periods determined by the Committee. It may also include the right to dividend equivalents if and as so determined by the committee. The Compensation Committee has discretion to determine the terms of any award of restricted stock or RSRs, including the number of shares subject to the award, and the minimum period over which the award may vest, and the acceleration of any vesting in the event of death, disability or change of control. RSRs are not transferable or assignable unless provided otherwise by the Compensation Committee with respect to certain specified family-related transfers. Unless the committee determines otherwise, once a RSR vests, the shares of common stock specified in the award will be issued to the participant. A participant who has been awarded RSRs may not vote the shares of common stock subject to the rights until the shares are issued. Until the vesting period applicable to a RSRs award expires and the shares are issued, the participant also may not transfer or encumber any interest in the RSRs or in any related dividend equivalents. Compensation expense for restricted stock rights is recognized over the period they vest.

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The Compensation Committee may also make stock awards of common stock without restrictions, except that if the award is in lieu of salary, service fee, cash bonus or other cash compensation, the number of shares covered by an award shall be based on the fair market value of such shares on the date of grant. Common Stock Awards under the plan may be issued free of restriction and may vest immediately; however, the Committee may impose vesting and other restrictions related to the grant of such common stock awards. Compensation expense for common stock awards is recognized over the period they vest, although generally the awards vest immediately.

There were no stock grants or issuances pursuit to the 2009 Plan during the six months ended June 30, 2015, and all underlying shares of the Company’s 2009 Stock Compensation Plan have been issued. As of June 30, 2015, there are no stock options, restricted stock awards, or restricted stock rights outstanding.

Stock Issued under the 2009 Plan

There were no stock awards granted during the six months ending June 30, 2015.

Fixed Assets

Property and equipment are carried at cost less accumulated depreciation and amortization. For financial statement purposes, depreciation and amortization is provided on the straight-line method over the estimated useful life of the asset ranging from 3 to 10 years.

Property and equipment are carried at cost less accumulated depreciation. For financial statement purposes, depreciation is provided on the straight-line method over the estimated useful life of the asset ranging from 3 to 10 years.


	(Unaudited)
Asset (Useful Life)	June 30, 2015	December 31, 2014
Software (3 years)	$ 84,224	$ 84,224
Computer equipment (3 - 5 years)	329,861	329,861
Furniture and fixtures (7 - 10 years)	231,033	231,033
Equipment (7 - 10 years)	122,868	101,052
Fixed assets, gross	767,986	746,170
Less accumulated depreciation	717,034	701,841
Fixed assets, net	$ 50,952	$ 44,329

Depreciation expense for property and equipment was $15,193 and $17,330 in the six months ended June 30, 2015, and the same period in 2014, respectively, and is reflected in selling, general and administrative expenses in the accompanying consolidated statements of operations and comprehensive income.

Goodwill and Other Intangible Assets

Intangible Assets – Intangible assets consist of acquired software and patents. Under ASC 350, “Goodwill and Other Intangible Assets,” such assets acquired including software technology is considered to have a finite life. Management has estimated the useful life to be 5 years and amortized such costs on a straight-line basis over this period. In addition, ASC 985-20, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed,” requires the Company to consider whether or not the software technology is impaired using a net realizable value analysis based on projected discounted cash flows. The Company prepared this analysis as of June 30, 2015, and the same period of 2014, and concluded that the intangible assets are not impaired. Patent acquisition costs pertaining to the Company’s 3i technology that covers its PinPoint™ and Signature Mapping™ intellectual property (technology not acquired through acquisition), have been capitalized and are being amortized over the 20-year legal life of the patents. The Company has been granted by the United States Patent & Trademark Office (“USPTO”) six patents related to its 3i technology. The Company evaluates the periods of amortization continually to determine whether later events or circumstances require revised estimates of useful lives. The Company’s intangible acquired software technology was fully amortized as of December 31, 2009. Therefore, there was no amortization costs associated with acquired software during the six months ended June 30, 2015, or during the same period in 2014. Amortization expense for patent acquisition costs was $12,065 and $12,065 in six months ended June 30, 2015, and 2014, respectively, and is reflected in selling, general and administrative expenses in the accompanying consolidated statements of operations and comprehensive income. The Company anticipates incurring additional patent acquisition costs during the year ending December 31, 2015.


	Six months ended June 30, 2015
	Beginning Period Cost			Net Book Value
	Beginning Period Cost	Additions	Reductions	Net Book Value
Intangibles with finite lives:
Patent acquisition costs	$ 291,725	$ 3,700	$ 12,065	$ 283,360

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Based on the net book value of patents acquisition costs at June 30, 2015, the Company estimates amortization expense for intangible assets to be $24,223 for Fiscal 2015, $24,315 for each of the Fiscal years 2016 through 2020, and $149,627 thereafter.

Excess of Purchase Price over Net Assets Acquired (Goodwill) – The Company follows the provisions of ASC 805-10, “Business Combinations” and ASC 350-10, “Goodwill and Other Intangible Assets.” These statements establish financial accounting and reporting standards for acquired goodwill. Specifically, the standards address how acquired intangible assets should be accounted for both at the time of acquisition and after they have been recognized in the financial statements. Effective January 1, 2002, with the adoption of ASC 350-10, goodwill must be evaluated for impairment and is no longer amortized. Excess of purchase price over net assets acquired (“goodwill”) represents the excess of acquisition purchase price over the fair value of the net assets acquired. To the extent possible, a portion of the excess purchase price is assigned to identifiable intangible assets. There was no goodwill on the consolidated balance sheet of the Company during the six months ended June 30, 2015, or the same period in 2014, as a net realizable value analysis was made for goodwill in prior years during the Company’s operating stage and such asset was fully impaired during those prior years.

Impairment of Excess Purchase Price over Net Assets Acquired – The Company follows the provisions of ASC 350-10 “Goodwill and Other Intangible Assets” for the impairment of goodwill. The Company determines impairment by comparing the fair value of the goodwill, using the undiscounted cash flow method, with the carrying amount of that goodwill. Impairment is tested annually or whenever indicators of impairment arise. There was no goodwill on the consolidated balance sheet of the Company for the six months ended June 30, 2015, or during Fiscal 2014 and, as a net realizable value analysis was made for goodwill in prior years and such asset was considered fully impaired during those prior years.

Impairment of Long-Lived Assets – The Company evaluates the carrying value of long-lived assets for impairment, whenever events or changes in circumstances indicate that the carrying value of an asset within the scope of ASC 360-10, “Accounting of the Impairment or Disposal of Long-Lived Assets” may not be recoverable. The Company’s assessment for impairment of assets involves estimating the undiscounted cash flows expected to result from use of the asset and its eventual disposition. An impairment loss recognized is measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset, and considers year-end the date for its annual impairment testing.

Uncertainty in Income Taxes

In June 2006, ASC 740-10 was established regarding the uncertainty in income taxes. ASC 740-10 establishes a recognition threshold and measurement for income tax positions recognized in an enterprise’s financial statements in accordance with accounting for income taxes. ASC 740-10 also prescribes a two-step evaluation process for tax positions. The first step is recognition and the second step is measurement. For recognition, an enterprise judgmentally determines whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of related appeals or litigation processes, based on the technical merits of the position. If the tax position meets the more-likely-than-not recognition threshold, it is measured and recognized in the financial statements as the largest amount of tax benefit that is greater than 50% likely of being realized. If a tax position does not meet the more-likely-than-not recognition threshold, the benefit of the position is not recognized in the financial statements.

Tax positions that meet the more-likely-than-not recognition threshold, at the effective date of ASC 740-10, may be recognized or, continued to be recognized, upon adoption of ASC 740-10. The cumulative effect of applying the provision of ASC 740-10 shall be reported as an adjustment to the opening balance of retained earnings for that fiscal year. ASC 740-10 applies to fiscal years beginning after December 15, 2006 with earlier adoption permitted. The Company has determined that as of June 30, 2015, no additional accrual for income taxes is necessary.

Recently Adopted Accounting Pronouncement

In June 2014, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance which eliminated the requirements for development stage entities (ASU 2014-10) to (1) present inception-to-date information in the statements of income, cash flows, and shareholders’ equity, (2) label the financial statements as those of a development stage entity, (3) disclose a description of the development stage activities in which the entity is engaged, and (4) disclose in the first year in which the entity is no longer a development stage entity that in prior years it had been in the development stage. The effective date for public entities is for annual reporting periods beginning after December 15, 2014, and interim periods therein. The public entity may adopt the guidance early for those financial statements not yet issued. The Company adopted the guidance with the issuance of its fiscal 2014 second quarter and the adoption of this disclosure-only guidance is not expected to have an impact on the Company's consolidated financial statements.

In July 2013, the FASB issued authoritative guidance that requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, in the financial statements as a reduction to a deferred tax asset for a net operating loss (“NOL”) carryforward, a similar tax loss, or a tax credit carryforward. If either (i) an NOL carryforward, a similar tax loss, or tax credit carryforward is not available as of the reporting date under the governing tax law to settle taxes that would result from the disallowance of the tax position or (ii) the entity does not intend to use the deferred tax asset for this purpose (provided that the tax law permits a choice), an entity should present an unrecognized tax benefit in the financial statements as a liability and should not net the unrecognized tax benefit with a deferred tax asset. This guidance becomes effective prospectively for unrecognized tax benefits that exist as of the Company’s fiscal 2015 first quarter, with retrospective application and early adoption permitted. The Company

15

adopted the guidance with the issuance of its fiscal 2015 first quarter and the impact of this balance sheet presentation guidance is not expect it to have a significant impact on the Company’s consolidated financial statements.

In February 2013, the FASB issued authoritative guidance requiring an entity to present, in a single location either parenthetically on the face of the financial statements or in a separate note, significant amounts reclassified from each component of accumulated other comprehensive income (loss) (“AOCI”) and the income statement line items affected by the reclassification. An entity is not permitted to provide this information parenthetically on the face of the income statement if it has items that are not required to be reclassified in their entirety to net income. Instead of disclosing the income statement line affected, a cross reference to other disclosures that provide additional details on these items is required. This guidance became effective prospectively for the Company’s fiscal 2014 first quarter and the adoption of this disclosure-only guidance is not expected to have an impact on the Company's consolidated financial statements.

Recently Issued Accounting Pronouncement

In April 2015, the FASB issued authoritative guidance that simplifies the presentation of debt issuance costs. Under the revised guidance, entities would no longer be able to recognize debt issuance costs as an asset in the balance sheet. The amendments in this update require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this update. This guidance becomes effective for the Company’s fiscal 2017 first quarter. Early adoption is only permitted for financial statements that have not been previously issued. Upon adoption, a reporting entity is required to apply the new guidance on a retrospective basis and required to comply with the applicable disclosures for a change in an accounting principle. The Company will apply this new guidance retrospectively when it becomes effective, and the adoption of this guidance is not expected to have a significant impact on its consolidated financial statements.

In April 2015, the FASB issued authoritative guidance to clarify the accounting treatment for fees paid by a customer in cloud computing arrangements. Under the revised guidance, if a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If the cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The revised guidance will not change a customer’s accounting for service contracts. The guidance becomes effective for the Company’s fiscal 2017 first quarter, with early adoption permitted. Upon adoption, a reporting entity can elect to apply the new guidance prospectively after the effective date, or retrospectively. The Company is currently evaluating the impact of adoption of this standard on its consolidated financial statements.

In June 2014, the FASB amended its authoritative guidance on accounting for certain share-based payment awards. The amended guidance requires that if share-based compensation awards have terms of a performance target that affect vesting and that could be achieved after the requisite service period, such performance target should be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant-date fair value of the award and compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved. This guidance becomes effective for the Company’s fiscal 2017 first quarter, with early adoption permitted. The guidance will permit an entity to apply the amendments in the update either (a) prospectively to all awards granted or modified after the effective date or (b) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the consolidated financial statements and to all new or modified awards thereafter. The Company will apply this new guidance when it becomes effective, and is currently evaluating the impact of adoption on its consolidated financial statements.

In May 2014, the FASB issued authoritative guidance that defines how companies should report revenues from contracts with customers. The standard requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. It provides companies with a single comprehensive five-step principles-based model to use in accounting for revenue and supersedes current revenue recognition requirements, including most industry-specific and transaction-specific revenue guidance. This guidance becomes effective for the Company’s fiscal 2018 first quarter, and early adoption is not permitted. In April 2015, the FASB proposed a deferral of the effective date of the new revenue standard by one year. The proposal will be subject to the FASB’s due process requirements, which include a period for public comments. If the proposed deferral is passed, the new standard would not be effective for the Company until fiscal 2019. The guidance permits an entity to apply the standard retrospectively to all prior periods presented, with certain practical expedients, or apply the requirements in the year of adoption, through a cumulative adjustment. The Company will apply this new guidance when it becomes effective and has not yet selected a transition method. The Company is currently evaluating the impact of adoption on its consolidated financial statements.

In April 2014, the FASB issued authoritative guidance which changes the criteria for a disposal to qualify as a discontinued operation. This revised standard defines a discontinued operation as (i) a component of an entity or group of components that has been disposed of or is classified as held for sale that represents a strategic shift that has or will have a major effect on an entity’s operations and financial results or (ii) an acquired business or nonprofit activity that is classified as held for sale on the date of acquisition. The standard also requires expanded disclosures related to discontinued operations and added disclosure requirements for individually

16

material disposal transactions that do not meet the discontinued operations criteria. This guidance becomes effective prospectively for the Company’s fiscal 2016 first quarter, with early adoption permitted, but only for disposals (or classifications as held for sale) that have not been reported in financial statements previously issued or available to be issued. The Company will apply this new guidance when it becomes effective, and the adoption of this guidance is not expected to have a significant impact on its consolidated financial statements.

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements—Going Concern. The provisions of ASU No. 2014-15 require management to assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. Specifically, the amendments (1) provide a definition of the term substantial doubt, (2) require an evaluation every reporting period including interim periods, (3) provide principles for considering the mitigating effect of management’s plans, (4) require certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans, (5) require an express statement and other disclosures when substantial doubt is not alleviated, and (6) require an assessment for a period of one year after the date that the financial statements are issued (or available to be issued). The amendments in this ASU are effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. The Company is currently assessing the impact of this ASU on the Company’s consolidated financial statements.

In June 2014, the FASB amended its authoritative guidance on accounting for certain share-based payment awards. The amended guidance requires that if share-based compensation awards have terms of a performance target that affect vesting and that could be achieved after the requisite service period, such performance target should be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant-date fair value of the award and compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved. This guidance becomes effective for the Company’s fiscal 2017 first quarter, with early adoption permitted. The guidance will permit an entity to apply the amendments in the update either (a) prospectively to all awards granted or modified after the effective date or (b) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the consolidated financial statements and to all new or modified awards thereafter. The Company will apply this new guidance when it becomes effective, and is currently evaluating the impact of adoption on its consolidated financial statements.

In May 2014, the FASB issued authoritative guidance that defines how companies should report revenues from contracts with customers. The standard requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. It provides companies with a single comprehensive five-step principles-based model to use in accounting for revenue and supersedes current revenue recognition requirements, including most industry-specific and transaction-specific revenue guidance. This guidance becomes effective for the Company’s fiscal 2018 first quarter, and early adoption is not permitted. The guidance permits an entity to apply the standard retrospectively to all prior periods presented, with certain practical expedients, or apply the requirements in the year of adoption, through a cumulative adjustment. The Company will apply this new guidance when it becomes effective and has not yet selected a transition method. The Company is currently evaluating the impact of adoption on its consolidated financial statements.

In April 2014, the FASB issued authoritative guidance which changes the criteria for a disposal to qualify as a discontinued operation. This revised standard defines a discontinued operation as (i) a component of an entity or group of components that has been disposed of or is classified as held for sale that represents a strategic shift that has or will have a major effect on an entity’s operations and financial results or (ii) an acquired business or nonprofit activity that is classified as held for sale on the date of acquisition. The standard also requires expanded disclosures related to discontinued operations and added disclosure requirements for individually material disposal transactions that do not meet the discontinued operations criteria. This guidance becomes effective prospectively for the Company’s fiscal 2016 first quarter, with early adoption permitted, but only for disposals (or classifications as held for sale) that have not been reported in financial statements previously issued or available to be issued. The Company will apply this new guidance when it becomes effective and the adoption of this guidance is not expected to have a significant impact on its consolidated financial statements.

Other ASU’s that have been issued or proposed by the FASB ASC that do not require adoption until a future date and are not expected to have a material impact on the financial statements upon adoption.

(3)

Financial Condition, Going Concern Uncertainties and Events of Default

The Company, previously an operating stage company, became a development stage company on April 1, 2012. A development stage company, as defined by ASC-915-10 “Accounting and Reporting by Development Stage Enterprise”, is an entity that devotes substantially all of its efforts to establish a business and either of the following conditions exists: 1) the principal operations have not commenced, or 2) the principal operations have commenced, but there has been no significant revenue therefrom. During 2015, Applied Visual Sciences’ revenue generating activities have not produced sufficient funds for profitable operations and we have incurred operating losses since inception. In view of these matters, realization of certain of the assets in the accompanying consolidated balance sheet is dependent upon continued operations, which in turn is dependent upon our ability to meet our financial requirements, raise additional financing on acceptable terms, and the success of future operations. Our independent registered public accounting firm’s report on the consolidated financial statements included herein, and in this Annual Report on Form 10-K for the

17

year ended December 31, 2014, contains an explanatory paragraph wherein they expressed an opinion that there is substantial doubt about our ability to continue as a going concern. Accordingly, careful consideration of such opinion should be given in determining whether to continue or become our stockholder. In addition, the Company is currently evaluating the impact of ASU No. 2014-15, Presentation of Financial Statements—Going Concern, on its disclosures regarding the Company’s ability to continue as a going concern.

As of June 30, 2015, the Company has outstanding trade and accrued payables of $1,826,743, other accrued liabilities of $290,478, and accrued salaries and related expenses due to our employees and management of $9,126,140. Also, the Company has an outstanding noninterest-bearing loan from its previous Chief Executive Officer of $80,500, and $807,500 short-term notes from a total of twenty (20) investors.

The principal amount of our outstanding Series A Debentures of $1,688,205 became due on July 1, 2011, and such amount was not paid. Therefore, the Company could be considered in default and may result in enforcement of the debenture holders’ rights and remedies under the debentures and applicable law. We have been in discussions with the debenture holders to re-negotiate the terms of the debentures, including the repayment or repurchase of the debentures and/or seek to extend their maturity date, although we have not reached any agreement with the debenture holders with regard to any such repayment, repurchase or extension. Our ability to repay or repurchase the debentures is contingent upon our ability to raise additional financing, of which there can be no assurance. Also, as a condition to any such extension, debenture holders may seek to amend or modify certain other terms of the debentures. When an event of default occurs under the debentures, the debenture holders may elect to require us to make immediate repayment of the mandatory default amount, which equals the sum of (i) the greater of either (a) 120% of the outstanding principal amount of the debentures, or (b) the outstanding principal amount unpaid divided by the conversion price on the date the mandatory default amount is either (1) demanded or otherwise due or (2) paid in full, whichever has the lower conversion price, multiplied by the variable weighted average price of the common stock on the date the mandatory default amount is either demanded or otherwise due, whichever has the higher variable weighted average price, and (ii) all other amounts, costs, expenses, and liquidated damages due under the debentures. In anticipation of such election by the debenture holders, due to the nonpayment of principal amount on the due date of July 1, 2011, we measured the mandatory default at approximately $337,641 and subsequently on each balance sheet date, which is reflected in the carrying value of the debentures and also recognized as interest expense. We remeasured the mandatory default amount as of June 30, 2015 at approximately $337,641. As of the date of this report, the debenture holders have not made an election requiring immediate repayment of the mandatory amount, although there can be no assurance they will not do so. The Company currently has insufficient funds to repay the outstanding amount in the event the debenture holders make a demand for payment.

As of June 30, 2015, we had a cash balance of $18,484. Management believes these funds to be insufficient to fund our operations for the next twelve months absent any cash flow from operations or funds from the sale of our equity or debt securities. Currently, will require an aggregate of approximately we are spending or incurring (and accruing) expenses of approximately $150,000 per month on operations and the continued research and development of our 3i technologies and products, including with regard to salaries and consulting fees. Management believes that we will require an aggregate of approximately $1,800,000 to fund our operations for the next 12 months and to repay certain outstanding trade payables and accrued expenses. This assumes that holders of our outstanding debentures convert such debt into shares of our common stock or that we are able to extend the term of the debentures, of which there can be no assurance. In the event we are unable to extend the term of the debentures beyond their new maturity date, the debenture holders do not convert such debt or require payment of principal, partially convert such debt, or effect the buy-in provision related to the debentures, we shall be required to raise additional financing. Also, this assumes that we are able to continue to defer the amounts due to our employees for accrued and unpaid salaries and that we are able to continue to extend or defer payment of certain amounts due to our trade creditors, of which there can be no assurance.

The Company has relied and continues to rely substantially upon equity and debt financing to fund its ongoing operations, including the research and development conducted in connection with its products and conversion of accounts payable for stock. The proceeds from our financings have been and continue to be insufficient to fund our operations, pay our trade payables, and repay our unconverted debentures or accrued and unpaid wages to our employees. Therefore, the debentures holders, our employees, or trade creditors may seek to enforce payment of amounts due to them, and our results of operations and financial condition could be materially and adversely affected and we may be unable to continue our operations. Also, in the event we continue to be unable to pay our employees, we may suffer further employee attrition. There can be no assurances that we will be successful in our efforts to raise any additional financing, any bank borrowing, and research or grant funding. Moreover, in view of the current market price of and limited trading volume in our stock, we may have limited or no access to the capital markets. Furthermore, under the terms of our agreements with the debenture holders, we are subject to restrictions on our ability to engage in any transactions in our securities in which the conversion, exercise or exchange rate or other price of such securities is below the current conversion price or is based upon the trading price of our securities after initial issuance or otherwise subject to re-set. In view of the foregoing, we may be required to curtail operations significantly, or obtain funds through entering into arrangements with collaborative partners or others that may require us to relinquish rights to certain of our technologies or products.

During the six months ended June 30, 2015, our total stockholders’ deficit increased by $299,319 to $13,870,115, and our consolidated net loss for the period was $359,319, compared to a net loss for the same period in 2014 of $304,524, or an increase of

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$54,795 (18.0%). Notwithstanding the foregoing discussion of management’s expectations regarding future cash flows, Applied Visual Sciences’ insolvency continues to increase the uncertainties related to its continued existence. Both management and the Board of Directors are carefully monitoring the Company’s cash flows and financial position in consideration of these increasing uncertainties and the needs of both creditors and stockholders.

(4)

Stockholders’ Equity

Common Stock Issued Including Exercises of Warrants and Options

On April 10, 2015, an aggregate of 2,000,000 common stock purchase warrants were exercised by an investor, and the Company issued 2,000,000 shares of common stock. Common stock was increased by $2,000 for the par value of the shares; paid-in capital was increased by $58,000.

Other Common Stock Purchase Warrants Issued, Expired, or Forfeited

During the six months ended June 30, 2015, an aggregate of 2,649,568 common stock purchase warrants expired, of which 150,000 Class M warrants, 2,199,568 Class N warrants, and 300,000 Class Q warrants issued to investors.

The Company has issued warrants as compensation to its note holders, placement agents and other consultants, as well as to incentivize investors in each of the Company’s private placement financings. The table below shows by category, the warrants issued and outstanding at June 30, 2015.


Common Stock Purchase Warrants	Number of Warrants Outstanding and Exercisable	Date Warrants are Exercisable	Exercise Price	Date Warrants Expire
Note and debenture holders	10,000	December 2007	$ 0.70	December 2015
	78,750	September 2010	0.25	September 2015
	88,750

Private placement investors	214,285	March 2008	0.75	December 2015
	2,632,725	August 2009	0.25	December 2018
	240,000	October 2009	0.25	December 2015
	400,000	November 2009	0.25	December 2016
	100,000	March 2010	0.25	December 2015
	200,000	March 2010	0.25	December 2016
	200,000	April 2010	0.25	December 2017
	3,731,155	July to Sept 2010	0.25	July to Sept 2015
	5,301,345	Oct to Dec 2010	0.25	Oct to Dec 2015
	400,000	February 2011	0.25	August 2015
	800,000	February 2011	0.25	February 2016
	88,000	October 2011	0.25	October 2015
	300,000	November 2014	0.25	December 2017
	14,607,510

Placement agents	72,000	February 2011	0.25	February 2016
	72,000

Consultants	200,000	December 2009	0.25	December 2015
	14,000	August 2010	0.28	August 2015
	14,000	September 2010	0.25	September 2015
	228,000

Total Warrants Issued/Outstanding	14,996,260

As of June 30, 2015, approximately 4,144,725 of the above warrants may be exercised pursuant to the cashless exercise provisions of such warrants and, if so exercised, the shares may be subsequently resold under the provisions of Rule 144 under the Securities Act. Increased sales volume of the Company’s common stock could cause the market price of the Company’s common stock to drop.

(5)

Subsequent Events

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Subsequent events are reported by the Company to disclose events that have occurred after the balance sheet date, but before the financial statements are issued. Such events may be to provide additional information about conditions that existed at the date of the balance sheet, or conditions that did not exist at the balance sheet date. The Company has evaluated subsequent events through the date of this report.

On August 6, 2015, a Company employee exercised 500,000 stock options for 500,000 shares of common stock using accrued and unpaid wages. The shares were issued under the 2003 Stock Incentive Plan. Common stock was increased by $500 for the par value of the shares, paid-in capital was increased by $14,500, and accrued wages was reduced by the total exercise price of $15,000.

(6)

Fair Value Measurement

The Company records its financial assets and liabilities at fair value, which is defined as the price that would be received to sell the asset or paid to transfer a liability, in the principal or most advantageous market for the asset or liability, in an orderly transaction between market participants at the measurement date. The fair value measurement of these liabilities is consistent with ASC 820, "Fair Value Measurements", whereby the Company is required to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of inputs that may be used to measure fair value are as follows:

Level 1:

Inputs based on quoted market prices for identical assets or liabilities in active markets at the measurement date.

Level 2:

Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3:

Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. The inputs are unobservable in the market and significant to the instrument’s valuation.

The following table presents the Company’s hierarchy for its financial assets and liabilities measured at fair value on recurring basis as of June 30, 2015:


	Level 1	Level 2	Level 3	Total
Assets
Cash	$ 18,484	$ -	$ -	$ 18,484

Liabilities
Convertible debentures	$ -	$ -	$ 2,025,846	$ 2,025,846
Derivative liabilities	-	-	67,528	67,528
Notes payable, net of discount	-	-	807,500	807,500
Notes payable and advances, related parties	80,500	-	-	80,500
Total	$ 80,500	$ -	$ 2,900,874	$ 2,981,374

The following table presents the Company’s hierarchy for its financial assets and liabilities measured at fair value on recurring basis as of December 31, 2014:


	Level 1	Level 2	Level 3	Total
Assets
Cash	$ 33,961	$ -	$ -	$ 33,961

Liabilities
Convertible debentures	$ -	$ -	$ 2,025,846	$ 2,025,846
Derivative liabilities	-	-	202,585	202,585
Notes payable, net of discount	-	-	807,500	807,500
Notes payable and advances, related parties	80,500	-	-	80,500
Total	$ 80,500	$ -	$ 3,035,931	$ 3,116,431

The estimated fair values of the Company’s derivative liabilities are as follows:


	Convertible	Derivative	Notes Payable
Liabilities Measured at Fair Value	Debentures (1)	Liabilities (2)	(3)	Total
Beginning balance as of December 31, 2013	$ 2,025,846	$ 540,226	$ 718,930	$ 3,285,002
Revaluation (gain)/loss in interest expense	-	(337,641)	-	(337,641)
Issuances, net of discount	-	-	68,000	68,000
Amortization of discount	-	-	20,570	20,570
Balance as of December 31, 2014	$ 2,025,846	$ 202,585	$ 807,500	$ 3,035,931
Revaluation (gain)/loss in interest expense	-	(135,057)	-	(135,057)

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Ending balance as of June 30, 2015		$ 2,025,846		$ 67,528		$ 807,500		$ 2,900,874

Total (gain)/loss from revaluations of derivatives and event of default included in earnings for the period and reported as an adjustment to interest is as follows:


	Convertible	Derivative	Notes Payable
Liabilities Measured at Fair Value	Debentures (1)	Liabilities (2)	(3)	Total
For fiscal 2014	$ -	$ (337,641)	$ 20,570	$ (317,071)
For six months ended June 30, 2015	-	(135,057)	-	(135,057)

(1) The balance as of December 31, 2014 and December 31, 2013, includes $1,688,205 for the outstanding convertible debentures issued November 8, 2006 and April 12, 2007, and an additional amount of $337,641 for the event of default provision under the debentures October 15, 2010 amendment agreement.

(2) Represents the conversion feature of outstanding convertible debentures issued November 8, 2006 and April 12, 2007. The fair value of the conversion feature since May 20, 2009, the final milestone reset date of the debentures, was determined using market quotation.

(3) The balance represents the outstanding short-term notes payable issued since October 2011, less remaining notes discount for the fair value of common stock when issued in conjunction with the notes. The note discount is being amortized over the original term of the notes. The outstanding notes payable at June 30, 2015 and December 31, 2014, is $807,500 and $807,500, respectively, and the outstanding notes discount at June 30, 2015 and December 31, 2014, is $0 and $0, respectively.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

You should read the following summary together with the more detailed information and consolidated financial statements and notes thereto and schedules appearing elsewhere in this report. Throughout this report when we refer to the “Company,” “Applied Visual Sciences,” “we,” “our” or “us,” we mean Applied Visual Sciences, Inc., and its subsidiaries.

This discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our critical accounting policies and estimates, including those related to revenue recognition, intangible assets, and contingencies. We base our estimates on historical experience, where available, and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions and conditions.

Except for historical information, the statements and other information contained in this Management’s Discussion and Analysis is forward-looking. Our actual results could differ materially from the results discussed in the forward-looking statements, which include certain risks and uncertainties. These risks and uncertainties include the rate of market development and acceptance of our “intelligent imaging informatics” (“3i™”) technology (particularly for our PinPoint™ and Signature Mapping™ products), the unpredictability of our sales cycle, the limited revenues and significant operating losses generated to date, and the possibility of significant ongoing capital requirements.

Our independent registered public accounting firm’s report on the consolidated financial statements included in our Annual Report Form 10-K for the year ended December 31, 2014, contains an explanatory paragraph wherein they expressed an opinion that there is substantial doubt about our ability to continue as a going concern. Accordingly, careful consideration of such opinion should be given in determining whether to continue or become our stockholder.

Our Business

Applied Visual Sciences, Inc. was incorporated under the name Guardian Technologies International, Inc., in the Commonwealth of Virginia in 1989 and reincorporated in State of Delaware in February 1996. We changed our name to Applied Visual Sciences, Inc., on July 9, 2010. The Company, previously an operating stage company, became a development stage company on April 1, 2012, the date of inception as a development stage company for financial reporting. Applied Visual Sciences, Inc. and its subsidiaries are collectively referred to herein as the “Company,” “Applied Visual Sciences, Inc.,” “Applied Visual,” “us,” “we,” or “our.”

Applied Visual Sciences is a software technology company that designs and develops computer-vision detection solutions for delivery to its target markets, aviation/homeland security and healthcare. Our two product lines are offered through our two operating subsidiaries as follows: Guardian Technologies International, Inc. for aviation/homeland security products and Signature Mapping Medical Sciences, Inc., for healthcare. On March 23, 2012, the Company established a new entity; Instasis Imaging, Inc., for the development, marketing, and sales of a suite of imaging analytic applications for the automated detection of breast cancer. We may engage in one or more acquisitions of businesses that are complementary, and may form wholly-owned subsidiaries to operate within defined vertical markets products.

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The Company utilizes imaging technologies and analytics to create integrated information management technology products and services that address critical problems experienced by corporations and governmental agencies in healthcare and homeland security. Each product and service can improve the quality and response time of decision-making, organizational productivity, and efficiency within the enterprise. Our product suite integrates, streamlines, and distributes business and clinical information and images across the enterprise.

Our Business Strategy

Our strategic vision is to position our core technology as the de facto standard for digital image analysis, knowledge extraction, and detection. Our strategy is based upon the following principal objectives:

·

Maintain product development and sales/marketing focus on large, underserved, and rapidly growing markets with a demonstrated need for intelligent computer-vision detection.

·

Leverage Applied Visual Sciences, Inc.’s technology, experienced management team, research and development infrastructure.

·

Focus our talents on solving highly challenging information problems associated with digital imaging analysis.

·

Establish an international market presence through the development of a significant OEM/Reseller network.

·

Build and maintain a strong balance sheet to ensure the availability of capital for product development, acquisitions, and growth.

·

Seek to broaden our investment appeal to large institutions.

To achieve our strategic vision, we are aware of the need to exercise the financial and operational discipline necessary to achieve the proper blend of resources, products and strategic partnerships. These efforts can accelerate our ability to develop, deploy and service a broad range of intelligent computer-vision detection solutions directly to our target markets and indirectly through OEM/value added reseller (“VAR”) partners. During 2013, we continued implementing changes across the spectrum of our business. We refined our marketing strategy for PinPoint™ and Signature Mapping™, and enhanced our Signature Mapping™ product offerings.

We may engage in one or more acquisitions of businesses that are complementary, and may form wholly-owned subsidiaries to operate within defined vertical markets.

Our Core Technology

Our core technology is an “intelligent computer-vision detection” (“3i™”) engine that is capable of extracting embedded knowledge from digital images, and has the capacity to analyze and detect image anomalies. The technology is not limited by type of digital format. It can be deployed across divergent digital sources such as still images, x-ray images, video and hyper-spectral imagery. To date, the technology has been tested in the area of threat detection for baggage scanning at airports, for bomb squad applications and the detection of tuberculosis by analyzing digital images of stained sputum slides captured through a photo microscopy system. Varying degrees of research and development have been conducted in the areas of detection for cargo scanning, people scanning, military target acquisition in a hyper-spectral environment, satellite remote sensing ground surveys and mammography CAD products and radiologists’ diagnostic imaging tools, and while product development in these areas is ongoing, there can be no assurance that we will successfully develop product offerings in these areas.

We are currently focused on providing software technology solutions and services in two primary markets - aviation/homeland security with PinPoint™ and healthcare technology with Signature Mapping™ solutions. However, as new or enhanced solutions are developed, we expect to expand into other markets such as military and defense utilizing hyper-spectral technology, and imaging diagnostics for the medical industry.

Aviation/Homeland Security Technology Solution - PinPoint™

Through our wholly-owned subsidiary, Guardian Technologies, we market our PinPoint™ product, which is an intelligent computer-vision automated target recognition technology for the detection and identification of guns, explosives, and other threat items contained in baggage, whether in the airport environment or for building security applications. PinPoint™ can identify threat items, notify screeners of the existence of threat items, and speed the security process by eliminating unnecessary baggage checks, provide the screener with an instantaneous second opinion, and reduce processing time spent on false positives (baggage selected for security review that contains no threat items). We market and seek to license the PinPoint™ product primarily to the United States Transportation Services Administration (TSA) for use in airports, the Federal Protection Services for use in federal buildings and to foreign governments and airport authorities. We compete with manufacturers of baggage screening, luggage and large parcel screening, people screening for weapons and explosive detection, container and vehicle screening, and cargo screening equipment and certain software companies and academic institutions that are developing solutions to detect threat items. It is also our intent to distribute the product through various distribution methods.

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The market for contraband detection systems has become intensely competitive and many of our competitors are better capitalized and have greater marketing and other resources than Applied Visual Sciences, Inc. Integration within currently deployed manufacturers’ scanning equipment is a requisite to anticipated sales, and is considered a significant development risk. PinPoint™ is available for sale to customers; however no sales are anticipated until we are able to seamlessly integrate with the manufacturers’ scanning equipment.

We will continue to pursue opportunities for the deployment of our PinPoint™ product as opportunities develop. With these uncertainties and our ability to manage with limited cash resources during 2015, we have focused on the development of our TBDx™ product, as better discussed below.

Healthcare Technology Solutions - Signature Mapping™

In an effort to expand upon the use of our core technology 3i™ intelligent computer-vision, we have modified our threat detection algorithms and quantitative imaging capabilities for use in the imaging field of diagnostic radiology and pathology. The technology is called Signature Mapping™. Our Signature Mapping™ platform technology represents the technological basis upon which our computer vision diagnostic radiology and pathology applications are being developed. Any Signature Mapping™ product introduced in the United States may be subject to Food and Drug Administration (“FDA”) review and approval, including with regard to its safety and effectiveness before we may begin marketing and selling any such product in the U.S. Such approval may require us to obtain extensive data from clinical studies to demonstrate such safety or effectiveness. The primary markets for our TBDx™ TB detection product are defined by the World Health Organization (“WHO”) as the twenty-two (22) nations with the highest burden of tuberculosis disease. These emerging nations, where the availability of capital may be limited, rely heavily on grant funding from international organizations such as The Global Fund, The Gates Foundation, PEPFAR and others. Those international funding agencies provide funding for the acquisition of technology, but only for technologies that have received WHO endorsement. During 2014 we completed clinical evaluations in South Africa and Nigeria, and commenced trials in Peru and Vietnam. The later trials were undertaken as part of our collaborative agreement with the Foundation for Innovative New Diagnostics (“FIND”). Data collected from the clinical trials will form the basis of our application to WHO for endorsement of our TBDx™ product.

Laboratory Pathology: SMDS™

Signature Mapping Detection System (“SMDS™”) is an automated hardware-software laboratory solution designed to operate one or multiple infectious disease applications via multi-threaded detection algorithms. SMDS™ automation software controls every movement of the integrated hardware components from slide management to image capture. Where SMDS™ is integrated with a specific infectious disease detection application; the solution is capable of automatically analyzing each field-of-view for the presence of specific characteristics of the targeted disease. The detection algorithms will perform with high sensitivity without sacrificing specificity. The end product is a flexible; user defined diagnostic patient report that can be integrated to a laboratory information system. Standard information includes patient information, processing date, field-of-view diagnostic findings and overall case severity or diagnostic finding.

TBDx™

TBDx™ is a fully-automated hardware and software technology platform that is capable of: (i) automatically managing 1-200 slides without human intervention, (ii) digitally capturing patient information (eliminates human recordation errors), (iii) adjusting focus for variances in sputum location, quality and topology, (iv) capturing high-quality digital images (standard 100 images per slide or user-defined), (v) automated identification of M Tuberculosis bacilli if present, and (vi) robust user-defined reporting and communication of diagnostic results.

Design initiatives have been discussed that would allow TBDx™ to be deployed at the point-of-care, a major strategic initiative of The World Health Organization. To advance these design ideas from concepts - to proof of concept - to working models ready for clinical evaluation, the company will need to develop strategic partnerships with academic institutions capable of providing targeted technological input and research capabilities. The company has begun the process of reaching out to academic institutions.

Radiology: BCDx™

The Company is adding vision to breast cancer diagnosis by developing a radiological suite of products, a breast cancer detection solution to be known as Signature Mapping™ Breast Cancer Detection (“BCDx™”). Annual estimates of breast cancer diagnostic activity within the U.S are: 35 million mammograms performed; 1.5 million biopsies performed; 87% of biopsies return a negative finding (mammogram ‘false positive’); 200,000 confirmed cancer cases; and immeasurable emotional, mental, and physical pain for the individuals and families of biopsy patients. The 1.3 million biopsies undertaken that resulted in negative findings can be directly attributed to an inability to resolve areas of concern due to the limited information provided in the mammography images. In addition, approximately 10% of cancerous lesions are missed – partly due to dense tissue obscuring the cancer or the appearance of cancer having common characteristics with the appearance of normal tissue. The goal of BCDx™ is to deliver sophisticated image analysis

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processes that provide enhanced visualization capabilities and automated detection algorithms to help prevent unnecessary biopsies, while flagging previously unseen lesions for additional review.

Similar to a person’s fingerprint, each tissue has a unique structure. Each structure creates a unique pattern or “signature” that can be extracted from an image to differentiate, locate, identify, and classify by using our Signature Mapping™ technology. Management anticipates BCDx™ to further help radiologists by visualizing the various structures within a particular tissue so they can be examined and quantified. This capability is expected to provide a next-generation image analysis, clarification, visualization and Signature Mapped™ “tissue characterization” and detection. Management believes that it will add significant clinical value to a wide range of difficult to detect diseases in diagnostic radiology by distinguishing and characterizing different tissue types in images regardless of the modality that generated the image.

Based on its unique properties, Signature Mapping™ is expected to be capable of being used to analyze images generated across all imaging modalities without the need for new image capture hardware costs. It will serve as a software-based, multi-modality approach to image analysis when combined with Signature Mapping’s™ unique” tissue characterization” and detection. As a result, Signature Mapping™ is expected to differentiate the contrast resolution between different tissue types, even when the material or tissue in the image is very diffuse or obscured by other objects, such as is the case where diseased lung tissue is located behind a rib in an x-ray chest examination. It is capable of displaying these ‘signatures’ in a way that empowers radiologists to make a more informed and confident diagnosis, even for hard to distinguish structures such as masses in dense breast tissue.

Signature Mapping™ appears to provide advantages for providing the knowledge for automatic detection. The development of a “tissue characterization” and detection model employs the use of supervised machine learning and contextual image analysis to analyze and classify the features associated with the newly created “signatures.” Unlike other pattern recognition methodologies, the 3i™ solution can reveal and differentiate inherent structures for all materials in an image regardless of: the imaging modality used to create the image, location within the image, shape or texture, and object orientation even if obscured by its relationship to other materials.

The Company has been engaged in discussions, negotiations, and due diligence on the formation of a strategic partnership focused exclusively on breast cancer computer vision detection technology. Our subsidiary, Instasis Imaging, would license Applied Visual’s core analysis technology platform for research and development, as well as for inclusion in the diagnostic products to be commercialized. Applied Visual would contribute its intellectual property, including patents, which are specific to the area of breast cancer detection. There can be no assurances that we will be successful in our efforts to establish a strategic partnership.

Clinical Experience and Medical Accomplishments

While Signature Mapping™ is expected to be capable of use in a wide range of medical image analysis applications, our initial application product development efforts are focused in four areas:

·

detection of tuberculosis by analyzing digital images of stained sputum slides captured through a photo microscopy system;

·

breast cancer detection using x-ray mammography, MRI and ultrasound;

·

neurological imaging analysis through the detection and quantification of acute intracranial hemorrhage using non-contrast CT, normal pressure hydrocephalus,

·

multiple sclerosis using MRI; and

·

chest radiography targeted at tuberculosis and silicosis detection using digital x-ray.

Development continues in the refinement of TBDx™ and its detection algorithms. Additional classifiers have been created to improve sensitivity, which is the measurement of correctly identifying positive cases, and specificity, which is the measurement of correctly identifying negative cases. The underlying scripting language has been re-written to enable laboratories to either use TBDx™ as a diagnostic tool or as a pre-screening technology that identifies probable candidate TB cases that are confirmed by a secondary technology. The ability to communicate to and from the camera and TBDx™ technology will permit the system to acquire a pre-set number of images, then move to another location on the slide and capture additional images. Also, the system can monitor the acquisition of the images and stop the acquisition process once the algorithms have determined that a case is severely infected. Internal testing continues to validate the progress of algorithm improvements.

Laboratory Pathology: TBDx™

In December 2014, the Company attended a five day TB conference held by The National Institute for Research in Tuberculosis (NIRT) Workshop in Chennai, India. The meeting was also attended by representatives from Advenio, Alere, GBD Bio, GeneDrive, ReaMatrix, and TB Biosciences. The primary objective of the workshop is was to introduce NIRT, The All India Institute of Medical Sciences (AIIMS), and other medical and laboratory directors overseeing Indian TB labs to companies possessing TB diagnostic technologies that could potentially be integrated into a laboratory diagnostic algorithm to help in the fight against TB in India. Catherina Boehme, CEO of the Foundation for Innovative New Diagnostics (FIND) providing a pipeline overview of new diagnostic

24

technologies emerging from the market. Afterwards she drew on years of experience in technology evaluations to present the FIND approach to developing study protocols and evaluating new diagnostic tests. There was continued emphasis on the World Health Organization’s (WHO) Target Product Profiles. The highest priority interest is in a screening or triage test, one that rules out the possibility of TB. This would require an affordable diagnostic test that has a high sensitivity and a lower specificity, but can be confirmed by a more specific diagnostic test. In presenting information about the Company’s TBDx™ automated system, it became evident that smear microscopy remains a routine diagnostic approach. It is the Company’s hope that TBDx™ will be included in the process to develop a protocol to evaluate our technology.

On November 18, 2014, the Company participated in an invitation only conference to launch the Nigerian National TB Prevalence Survey Report & National Strategic Plan for TB (2015 – 2020). The conference took place for three days and was held in Abuja, Nigeria. This was a significant event given the announcement that for every 100,000 persons living in Nigeria – 338 persons developed TB, that Nigeria accounted for 15% (about half a million) of the global gap in TB case notification, which equates to approximately 83% of the estimated total TB positive cases in Nigeria (2014 WHO Global TB Report for 2013). Much of the reporting gap can be attributed to the passive nature of TB case detection around the world. Patients must come to the diagnostic health facilities. In an active diagnostic program the healthcare diagnostic applications would be targeted and delivered proactively to the source of the disease, generally economically distressed areas of big cities or very remote villages. TBDx™ has been clinically evaluated and proven as a cost-effective screening or triage device that can be easily incorporated into an active case finding initiative. Furthermore, combining TBDx™ with a confirming molecular test can potentially result in cost reductions of up to 75%. Those cost savings could be used to offset the costs to paradigm shift to active case detection, and to positively impact the transmission rate of TB. While at the conference, The Company’s Director of Engineering, Tosh Sondh, demonstrate the 200-slide auto-loading, high-volume edition of TBDx™. He also had the opportunity to conduct one-on-one demonstrations and technology discussions with each of the Nigerian State TB program managers. It was a unique opportunity for the managers to see TBDx™ as they rarely see and experience new technologies.

On March 19, 2014, the Company signed a collaboration agreement with the Foundation for Innovative New Diagnostics (FIND) to evaluate the performance characteristics of the TBDx™ automated slide management and tuberculosis detection platform in a field setting. The mission of the FIND is to assist in the development and deployment of accurate and affordable diagnostic tests for poverty-related diseases in developing countries. The primary objectives of the study are to: (i) determine the sensitivity, specificity, and predictive values of TBDx™ among adult TB suspects, using culture as the gold standard, (ii) compare the performance of TBDx™ to routine laboratory LED Fluorescent Microscopy (LED/FM), and (iii) determine the feasibility of using the TBDx™ system at a high workload reference laboratory. The studies with take place at two locations chosen by FIND.

1.

The first clinical evaluation was performed at the Instituto de Medicina Tropical Alexander von Humboldt, Universidad Peruana Cayetano Heredia, in Lima, Peru. The principal investigator is Dr. Eduardo Gotuzzo. Managing the project study for FIND will be Dr. Pamela Nabeta. The study began in October 2014 and was completed February 2015.

2.

The second clinical evaluation will take place at the Pham Ngoc Thach Tuberculosis and Lung Disease Hospital in Ho Chi Minh City, Vietnam, where the laboratory conducts an approximately 700 to 1,000 cases daily. The study began in March 2015 and was completed in May 2015.

In February 2014, the Company began a research study in Abuja, Nigeria. The study, funded by the European and Developing Countries Clinical Trial Partnership (EDCTP), involved the Liverpool School of Tropical Medicine, both the Federal and State Tuberculosis and Leprosy Control Programs, and the Zankli Medical Center. The purpose of the study was to evaluate the performance of TBDx™ in a typical laboratory environment. However, there are important differences from the previous South Africa trial in 2013. The study involved microscopy smears that are direct, rather than concentrated. The majority of global labs evaluate direct smears so it’s important to understand whether or not there are performance differences in the analysis of these images. TBDx™ was evaluated as a “screening” technology for two different molecular tests. In the South Africa trial a molecular test was used to confirm all TBDx™ positive cases, and a second molecular test manufacturer was added to the trial, and performance comparisons were made between them. The study was completed in July 2014 and included approximately 1,200 cases being evaluated.

Breast Cancer Detection: BCDx™

Our research to-date includes five programs and studies conducted under the direction of the Image Processing and Informatics Laboratory at the University of Southern California (“USC”) using clinical data and images provided by: the Image Processing and Informatics Laboratory at USC, Howard University, and the South Florida Clinical Mammography Data Base. Competition is expected with existing computer-aided-detection (“CAD”) manufactures such as iCAD, Hologic, Siemens, or Carestream Health. We may partner with one or more of these existing CAD manufacturers, or with an emerging company with new technology for the CAD arena. Once our products are commercially viable, we anticipate marketing and selling our products through original equipment manufacturers (“OEM”), or system integrators.

The Disease

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Breast cancer is the second leading cause of cancer deaths in women (after lung cancer) and is the most common cancer among women, excluding skin cancers, accounting for 1 of every 3 cancers diagnosed. The lifetime probability of developing invasive breast cancer is approximately 1 in 8 (12%). Annual estimates from the American Cancer Society (ACS) indicate that 1.5 million women will develop breast cancer worldwide and 460,000 will die from the disease. In the U.S. the mortality rate is about 1 in 35 women. Ineffective workflow, poor communications and decision-support tools cost over $8.5 billion per year.


Breast imaging procedures	About 35 million screening exams
Biopsy procedures	About 1.5 million biopsies conducted
12% - 15% of biopsies are positive	168,000 detected cancers
Mortality rate	About 40,950 women
Biopsy per procedure cost	$1,000 - $3,000 dollars
Annual gross national biopsy cost	$1.5 - $4.5 billion dollars
A 10% reduction in biopsies would save approximately	$150 - $500 million dollars

Source: NIH, Annual breast exams in the U.S. 2011.

Detection

Early detection is a critical factor for controlling survival. Early detection provides increased therapeutic options and improved probability of survival. Mammography is a reliable and cost-effective screening technology. When properly conducted, mammography has been estimated to reduce breast cancer mortality by 20-30%. Currently, ductal carcinoma-in-situ (DCIS) represents 25%-30% of all reported breast cancers. Approximately 95% of all DCIS are diagnosed because radiologists identify them in mammograms. However, reading mammograms is difficult and prone to misinterpretation, subjectivity, and misreads. Studies have found that screening x-ray exams are about 80% accurate at best and that lesions are simply not detected 10% to 15% of the time. The National Cancer Institute reported that 25% of breast tumors are missed in women in their forties. (See Liu B, Z. M., Document J (2005, "Utilizing data grid architecture for the backup and recovery of clinical image data." Comput Med Imaging Graph. 29(2-3): 95-102, and National Cancer Institute, "Cancer in African American Women.")

Dense breasts pose a greater challenge to cancer detection using mammograms, especially early-stage breast cancers. Approximately 25% of women have dense breasts; thus a large number of mammograms, especially in AAW, are more difficult to clinically interpret. The risk of breast cancer associated with the highest category of density is estimated to be two to six times greater than for women with the lowest category of breast density.

Clinical Value of Signature Mapping™

On the basis of our initial studies, the signatures of malignant tumors in mammograms exhibit significant differences when compared with cysts, benign lesions, or dense breast tissue after being processed with Signature Mapping™. Measurable differences exist among different breast structures in both the spatial and frequency domains. Signatures of different tissues vary in their entropy, linearity, boundary gradients, and homogeneity. As a result, the internal structure of masses in dense breast tissue can be characterized and identified and displayed radiographically to the clinician. Signature Mapping™ is expected to visually display levels within the tumor and distortions in the breast geometry outside the tumor.

The effectiveness of these algorithms was evaluated through a pilot study conducted with the Norris Cancer Center at the University of Southern California. The study consisted of two sets of mammographic cases, a training set and a testing set. Both sets contained 40 normal and 40 confirmed solid cancer masses and were matched for levels of interpretation difficulty and patient age, variations in breast density, and types of tumors. Applied Visual used the training set for the development of its algorithms and for training the participating radiologists in the study. The test set was used in the pilot study to gain clinical feedback and determine the effectiveness of the radiologist’s interpretations using Signature Mapping™. Preliminary clinical results based on the visual performance of five highly-skilled and experienced mammographers using the mammography-specific Signature Mapping™ process demonstrated improved accuracy and ease of use in the study.

Clustered micro-calcifications may be the only visually detectable manifestation of early breast cancer. Mammography is very responsive to the presence of micro-calcifications, however, the specificity of mammography remains low. Benign calcifications cannot always be distinguished from those indicating malignancy resulting in a large population of women who do not have cancer, but are subjected to biopsy. Using Signature Mapping™ we expect that the miniscule structures within micro-calcifications can be characterized and their potential for pathology identified by the radiologists.

While carcinomas are rarely found in cysts, they are difficult to accurately diagnose through the use of mammography because they cannot be distinguished from other well circumscribed solid masses unless they display several characteristic patterns of calcification. Applied Visual is optimizing Signature Mapping™ for the accurate characterization of cysts as part of ongoing development that includes an early-onset cancer detection model.

Sales

26

Sales for products within our specific markets are conducted through both direct sales and indirect distribution channels worldwide.

Product Distribution and Marketing

We have entered into the following distributor, strategic partnership, development, and consulting agreements with regard to our products, although they have not produced revenue for the Company:

Master Development Agreement with Aurum Innova (Pty), Ltd.

On February 4, 2009, Applied Visual Sciences, Inc. signed a Master Development Agreement Aurum Innova (Pty), Ltd., a company related to the Aurum Institute for Health Research, and installed in February 2009 an alpha product of Signature Mapping™ tuberculosis (“TBDx™”) software in a “retrofit configuration” for an evaluation by the National Health Laboratory Services (“NHLS”) in South Africa. This agreement extends the Company’s contractual relationship with Aurum that was first established with the signing of a Memorandum of Understanding on July 25, 2008. The new agreement provides for the joint development of products and services aimed at the screening, early detection and staging of diseases including TB, silicosis, and malaria. Each product will be the subject of a separate project specifications and the MDA included project specifications for our joint development of an automated TB sputum detection product. Aurum has agreed to clinically evaluate the products, and the parties agreed to jointly market and sell, initially in South Africa but eventually in sub-Saharan Africa, the jointly developed products, including our Signature Mapping™ TBDx™ product, through third parties and/or through Aurum. The Company agreed to pay Aurum a royalty on a product by products basis, based on the net revenue received by us through our distributors, and to be delineated by the parties. Also, the Company agreed to pay Aurum a commission with regard to sales of the products by Aurum. Further, Aurum has agreed to use every reasonable effort to raise funding to complete the development of a product following completion of the initial proof of concept. Any intellectual property jointly developed by us and Aurum will be jointly owned. The agreement may be terminated on one year’s prior written notice by either party, automatically terminates upon completion of project specifications and if no products are being marketed under the agreement, or for cause. The agreement also contains certain confidentiality and indemnification provisions.

Patents and Proprietary Rights

We rely on a combination of common law trademark, service mark, copyright and trade secret law and contractual restrictions to establish and protect our proprietary rights and promote our reputation and the growth of our business. We do not own any patents that would prevent or inhibit our competitors from using our technology or entering our market, although we intend to seek such protection as appropriate. It is our practice to require all of our employees, consultants and independent contractors to enter into agreements containing non-disclosure, non-competition and non-solicitation restrictions and covenants, and while our agreements with some of our customers and suppliers include provisions prohibiting or restricting the disclosure of proprietary information, we can not assure you that these contractual arrangements or the other steps taken by us to protect our proprietary rights will prove sufficient protection to prevent misappropriation of our proprietary rights or to deter independent, third-party development of similar proprietary assets.

The United States Patent & Trademark Office (“USPTO”) has granted the Company six patents, and we were granted one foreign patent, all of which are related to our underlying 3i™ technology. We also have three pending patents applications (U.S. and foreign) that further cover the implementation of our core 3i™ technology. We cannot provide assurance that any or all of the remaining patent applications or provisional applications will be issued patents, or that they will not be challenged, or that rights granted to us would actually provide us with an advantage over our competitors. Prior art searches have been conducted and, based on the results of these searches; we believe that we do not infringe any third party patents identified in the searches.


Date Granted	Patent No.	Patent Description
February 17, 2009	7,492,937	System and Method for Identifying Objects of Interest in Image Data
February 24, 2009	7,496,218	System and Method for Identifying Objects of Interest in Image Data
December 31, 2009	MY-140267-A7,907,762	System and Method for Identifying Objects of Interest in Image Data (Malaysian)
October 19, 2010	7,817,833	System and Method for Identifying Feature of Interest in Hyperspectral Data
November 23, 2010	7,840,048	System and Method for Determining Whether There is an Anomaly in Data
March 15, 2011	7,907,762	Method of Creating a Divergence Transform for Identifying a Feature of Interest in Hyperspectral Data
October 25, 2011	8,045,805	Method for Determining Whether a Feature of Interest Anomaly is Present in an Image

Due to the rapid pace of technological change in the software industry, we believe patent, trade secret and copyright protection are less significant to our competitive edge than factors such as the knowledge, ability and experience of our personnel, new product development, frequent product enhancements, name recognition and the ongoing reliability of our products.

Principal Offices

27

We maintain our principal office at 525K East Market Street, # 116, Leesburg, Virginia, 20176. Our telephone number in the U.S. is (703) 539-6190. Our Internet address is www.appliedvs.com, and the Company also disseminates information on Facebook at https://www.facebook.com/appliedvs and Twitter at https://mobile.twitter.com/appliedvs. Such information on our website, Facebook and Twitter is not deemed to be part of this Quarterly Report on Form 10-Q.

CONSOLIDATED RESULTS OF OPERATIONS

Results of Operations

Three months ended June 30, 2015 Compared to the three months ended June 30, 2014

The following analysis reflects the condensed consolidated results of operations of the Company and its subsidiaries.

Net Revenues. There were no revenues for three months ended June 30, 2015, or for the same period in 2014.

Cost of Sales. There was no cost of sales for three months ended June 30, 2015, and the same period in 2014.

Selling, General and Administrative Expenses. Selling, general and administrative expenses for three months ended June 30, 2015 of $226,685, decreased by $5,549 (2.4%), as compared to $232,234 for the same period in 2014. The table below details the components of selling, general and administrative expense, as well as the dollar and percentage changes for the three month period.


	Three Months Ended June 30
	2015	2014	$ Change	% Change
Payroll and related costs	$ 172,245	$ 158,069	$ 14,176	9.0
Professional fees	33,846	33,871	(25)	(0.1)
Research and development costs	-	17,087	(17,087)	(100.0)
Other operating expenses	6,966	11,325	(4,359)	(38.5)
Depreciation and amortization	13,628	11,858	1,770	14.9
Stock-based compensation	-	24	(24)	(100.0)
Total	$ 226,685	$ 232,234	$ (5,549)	(2.4)

Payroll and related costs, which includes salaries, commissions, taxes and benefits, increased $14,176 (9.0%), due to increased business development activities. During 2015, the Company employed three full-time and one part-time employee, and during 2014, four full-time, and one part-time employee.

Professional fees include legal, accounting, stock transfer agent, SEC filing, and general consulting fees. Professional fees decreased for the three months ended June 30, 2015 versus the same period last year by $25 (0.1%) due to: (i) a decrease of $8,119 for general consultants, legal counsel, accounting, and miscellaneous services and fees, and (ii) an increase in information technology consulting fees of $8,094.

Research and development (“R&D”) costs decreased for the three months ended June 30, 2015, compared to the same period last year by $17,087 (100.0%). During 2015, the staff focused on business development for Signature Mapping TBDx™ and there were no product development or clinical evaluation activities for the period.

Other operating expenses decreased by $4,359 (38.5%) to $6,966 for the three months ended June 30, 2015, as compared to $11,325 for the same period in 2014. The decrease is attributed to: (i) $4,189 for decreased travel expenses, and (ii) decreased administrative costs of $170.

Depreciation and amortization expense is determined on the straight-line method over the estimated useful life of the asset, which for equipment and furniture ranges from 3 to 10 years, and for intangible assets (patent acquisition costs capitalized) and are being amortized over the 20-year legal life of the patents.

Stock-based compensation, which represents a noncash expense category, is the amortization of the estimated fair value of stock-based compensation to employees, non-employee members of our Board of Directors, and consultants in lieu of cash compensation. Employee stock option expense for the 2015 and 2014 represents the amortization of the Black-Scholes fair value as outlined above in accordance with ASC 718-10. ASC 718-10 requires the recognition of all share-based payments to employees or to non-employee directors, as compensation for service on the Board of Directors, as compensation expense in the consolidated financial statements. The amount of compensation is measured based on the estimated fair values of such stock-based payments on their grant dates, and is amortized over the estimated service period to vesting. The Company issued stock-based compensation to management and other employees during 2013, and none during 2014 or 2015. During the three months ended June 30, 2015, the Company recognized an expense associated with employees, including its named executives, for stock-based compensation of $0, and $24 for the same period

28

in 2014, or a decrease of $24 (100.0%). Consulting expense for stock-based payments to consultants is based on the fair value of the stock-based compensation at inception and amortized over the estimated service period but, in accordance with ASC 505-50, is remeasured on each reporting date until the performance commitment is complete. During the three months ended June 30, 2015, the Company recognized an expense for stock-based compensation to consultants of $0, compared to $0 during the same period in 2014, since no stock-based compensation was granted to consultants during the period.

Other Income (Expense). Other income (expense) includes interest income, interest expense and other non-operating income and expense. Net other income for three months ended June 30, 2015 was $37,899, compared to the same period in 2014 of $104,606, for a decrease in other income of $66,707 (63.8%).

There was no interest income from interest bearing accounts for the three months ended June 30, 2015, or for the same period in 2014, due to low average daily cash balances in interest bearing accounts during the periods.

The components of non-operating items for the three months ended June 30, 2015, and the same period in 2014, and the variances include: (i) ) debt discount amortization costs in 2015 of $0 and $5,537 in 2014, or a decrease in expense of $5,537 (100.0%), (ii) interest expense in 2015 for short-term notes of $29,629, whereby $24,913 for the same period in 2014, or an increase of $4,716 (18.9%), (iii) income of $67,528 in 2015 for the revaluation of beneficial conversion feature of the outstanding debentures, compared to $135,056 in 2014, or a decrease in income of $67,528 (50.0%). Non-cash non-operating income included above for the three months ended June 30, 2015 was $67,528, compared to non-operating income of $129,519 for the same period in 2014, or a decrease in non-cash non-operating income of $61,991 (47.9%).

Net Loss and Net Loss per Common Share. Net loss for three months ended June 30, 2015 was $188,786, compared to $127,628 for the same period in 2014, for an increase in net loss of $61,158 (47.9%). Net loss for the Company per common share (“basic EPS”) is computed by dividing net income (loss) by the weighted average number of shares outstanding. Net loss per common share assuming dilution (“diluted EPS”) is computed by reflecting potential dilution from contingently issuable shares (i.e. common stock purchase warrants and stock options issued and outstanding).

Reconciliation between the numerators and denominators of the basic EPS computations is as follows:


	Three Months Ended June 30
	2015	2014
Numerator:
Net loss	$ (188,786)	$ (127,628)

Denominator:
Weighted average common shares outstanding - basic	106,530,810	103,138,601

Net loss per common share:
Basic	$0.00	$0.00

Six months ended June 30, 2015 Compared to the six months ended June 30, 2014

The following analysis reflects the condensed consolidated results of operations of the Company and its subsidiaries.

Net Revenues. There were no revenues for six months ended June 30, 2015, or for the same period in 2014.

Cost of Sales. There was no cost of sales for six months ended June 30, 2015, and the same period in 2014.

Selling, General and Administrative Expenses. Selling, general and administrative expenses for six months ended June 30, 2015 of $446,302, decreased by $69,436 (13.5%), as compared to $515,738 for the same period in 2014. The table below details the components of selling, general and administrative expense, as well as the dollar and percentage changes for the six month period.


	Six Months Ended June 30
	2015	2014	$ Change	% Change
Payroll and related costs	$ 324,001	$ 389,489	$ (65,488)	(16.8)
Professional fees	64,214	43,228	20,986	48.5
Research and development costs	10,031	27,324	(17,293)	(63.3)
Other operating expenses	20,799	16,023	4,776	29.8
Depreciation and amortization	27,257	29,395	(2,138)	(7.3)
Stock-based compensation	-	10,279	(10,279)	(100.0)
Total	$ 446,302	$ 515,738	$ (69,436)	(13.5)

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Payroll and related costs, which includes salaries, commissions, taxes and benefits, decreased $65,488 (16.8%), due to a reduction in full-time staff of $89,479, reduced by increased business development versus research and development activities of $20,991. During 2015, the Company employed three full-time and one part-time employee, and during 2014, four full-time, one part-time employee.

Professional fees include legal, accounting, stock transfer agent, SEC filing, and general consulting fees. Professional fees increased for the six months ended June 30, 2015 versus the same period last year by $20,986 (48.5%) due to: (i) a decrease of $13,014 for general consultants, legal counsel, accounting, and miscellaneous services and fees, and (ii) an increase in information technology consulting fees of $34,000.

Research and development (“R&D”) costs decreased for the six months ended June 30, 2015, compared to the same period last year by $17,293 (63.3%). There were no research and development activities Signature Mapping TBDx™ during the three months ended June 30, 2015, or a reduction of $17,087 compared to the same period in 2014, and there were lower R&D costs in the first quarter of 2015 by $206.

Other operating expenses increased by $4,776 (29.8%) to $20,799 for the six months ended June 30, 2015, as compared to $16,023 for the same period in 2014. The increase is attributed to: (i) increased equipment purchases of $3,111, and (iii) increased administrative costs of $1,665.

Depreciation and amortization expense is determined on the straight-line method over the estimated useful life of the asset, which for equipment and furniture ranges from 3 to 10 years, and for intangible assets (patent acquisition costs capitalized) and are being amortized over the 20-year legal life of the patents.

Stock-based compensation, which represents a noncash expense category, is the amortization of the estimated fair value of stock-based compensation to employees, non-employee members of our Board of Directors, and consultants in lieu of cash compensation. Employee stock option expense for the 2015 and 2014 represents the amortization of the Black-Scholes fair value as outlined above in accordance with ASC 718-10. ASC 718-10 requires the recognition of all share-based payments to employees or to non-employee directors, as compensation for service on the Board of Directors, as compensation expense in the consolidated financial statements. The amount of compensation is measured based on the estimated fair values of such stock-based payments on their grant dates, and is amortized over the estimated service period to vesting. The Company issued stock-based compensation to management and other employees during 2013, and none during 2014 or 2015. During the six months ended June 30, 2015, the Company recognized an expense associated with employees, including its named executives, for stock-based compensation of $0, and $10,279 for the same period in 2014, or a decrease of $10,279 (100.0%). Consulting expense for stock-based payments to consultants is based on the fair value of the stock-based compensation at inception and amortized over the estimated service period but, in accordance with ASC 505-50, is remeasured on each reporting date until the performance commitment is complete. During the six months ended June 30, 2015, the Company recognized an expense for stock-based compensation to consultants of $0, compared to $0 during the same period in 2014, since no stock-based compensation was granted to consultants during the period.

Other Income (Expense). Other income (expense) includes interest income, interest expense and other non-operating income and expense. Net other income for six months ended June 30, 2015 was $37,899, compared to the same period in 2014 of $104,606, for a decrease in other income of $66,707 (63.8%).

There was no interest income from interest bearing accounts for the six months ended June 30, 2015, or for the same period in 2014, due to low average daily cash balances in interest bearing accounts during the periods.

The components of non-operating items for the six months ended June 30, 2015, and the same period in 2014,and the variances include: (i) ) debt discount amortization costs in 2015 of $0 and $15,541 in 2014, or a decrease in expense of $15,541 (100.0%), (ii) interest expense in 2015 for short-term notes of $48,074, whereby $43,358 for the same period in 2014, or an increase in interest expense of $4,716 (10.9%), (iii) income of $135,057 in 2015 for the revaluation of beneficial conversion feature of the outstanding debentures, compared to $270,113 in 2014, or a decrease in income of $135,056 (50.0%). Non-cash non-operating income included above for the six months ended June 30, 2015 was $135,057, compared to non-operating income of $254,572 for the same period in 2014, or a decrease in non-cash non-operating income of $119,515 (46.9%).

Net Loss and Net Loss per Common Share. Net loss for six months ended June 30, 2015 was $359,319, compared to $304,524 for the same period in 2014, for an increase in net loss of $54,795 (18.0%). Net loss for the Company per common share (“basic EPS”) is computed by dividing net income (loss) by the weighted average number of shares outstanding. Net loss per common share assuming dilution (“diluted EPS”) is computed by reflecting potential dilution from contingently issuable shares (i.e. common stock purchase warrants and stock options issued and outstanding).

Reconciliation between the numerators and denominators of the basic EPS computations is as follows:

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	Six Months Ended June 30
	2015	2014
Numerator:
Net loss	$ (359,319)	$ (304,524)

Denominator:
Weighted average common shares outstanding - basic	105,634,689	102,948,463

Net loss per common share:
Basic	$0.00	$0.00

LIQUIDITY AND CAPITAL RESOURCES

The following table presents a summary of our net cash provided by (used in) operating, investing and financing activities:


	Six Months Ended June 30
Category	2015	2014
Net cash (used in) operating activities	$ (49,961)	$ (23,355)
Net cash (used in) investing activities	(25,516)	-
Net cash provided by financing activities	60,000	33,000
Net increase (decrease) in cash	$ (15,477)	$ 9,645

Net Cash Used in Operating Activities

Net cash used in operating activities for the six months ended June 30, 2015, was $49,961, compared with net cash used in operating activities of $23,355 during the same period for 2014, or an increase in the use of cash for operating activities of $26,606 (113.9%). The increase in the use of cash is due to: (i) lower operating costs including, but not limited to a decrease in selling, general and administrative costs (other than depreciation and amortization, and stock based compensation) of $52,303 (10.1%), and (ii) offset by a net decrease in components of operating assets and liabilities of $78,909 (15.9%).

Net Cash Used in Investing Activities

Net cash used in investing activities for the six months ended June 30, 2015 was $25,516, versus no investing activities for the same period in 2014. The net increase in cash used in investing activities of $25,516 was for the purchase of equipment for our TBDx™ clinical evaluation activities in Vietnam of $21,816, and $3,700 for patent costs. The Company anticipates it will incur additional equipment costs during the current fiscal year ending December 31, 2015, as we continue the certification process of TBDx™ in other countries.

Net Cash Provided by Financing Activities

Proceeds from financing activities for the six months ended June 30, 2015 was $60,000, compared to $33,000 for the same period for 2014, or an increase in net cash provided by financing activities of $27,000 (81.8%). Management is seeking, and expects to continue to seek to raise additional capital through equity or debt financings or bank borrowings, including through one or more equity or debt financings or bank borrowings to fund its operations, repay or repurchase its debentures, and pay amounts due to its creditors and employees. However, there can be no assurance that the Company will be able to raise such additional equity or debt financing or obtain such bank borrowings on terms satisfactory to the Company or at all.

Cash

Our cash decreased during the six months ended June 30, 2015 by $15,477, compared to an increase in cash during the same period in 2014 of $9,645, or a decrease in cash of $25,122 (260.5%). As outlined above, the decrease in cash for the current period in 2015 was the result of; (i) cash used in operating activities of $49,961, (ii) cash used in investing activities of $25,516, and (iii) cash provided by financing activities of $60,000. The decrease in cash for the current period in 2014 was the result of; (i) cash used in operating activities of $23,355, (ii) no cash used in investing activities, and (iii) cash provided by financing activities of $33,000. The net change in cash for the six months ended June 30, 2015, as compared to the same period in 2014, was $25,122, and is the result of (i) an increase in cash used in operating activities of $26,606, (ii) an increase in investing activities of $25,516, and (iii) an increase in financing activities of $27,000.

Working Capital Information - The following table presents a summary of our working capital at the end of each period:

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	(unaudited)
Category	June 30, 2015	December 31, 2014
Cash	$ 18,484	$ 33,961

Current assets	20,308	36,285
Current liabilities	14,224,735	13,943,135
Working capital (deficit)	$ (14,204,427)	$ (13,906,850)

Cash is stated at cost, which approximates fair value, and consists of interest and noninterest bearing accounts at a bank. Balances may periodically exceed federal insurance limits. The Company does not consider this to be a significant risk. The Company considers all highly liquid debt instruments with initial maturities of 90 days or less to be cash equivalents. There were no cash equivalents as of June 30, 2015 and December 31, 2014, respectively.

As of June 30, 2015, the Company had a working capital deficit of $14,204,427, compared to $13,906,850 at December 31, 2014, or an increase in working capital deficit of $297,577 (2.1%). As of June 30, 2015, the Company had cash of $18,484 as compared to $33,961 on December 31, 2014. The decrease in cash of $15,477 is the net result of our operating, investing and financing activities outlined above. For the six months ended June 30, 2015, current liabilities increased $281,600 (2.0%), with specific decrease in current liabilities of $135,057 for the revaluation of derivative liabilities related to the outstanding debentures, and specific increases in current liabilities of $213,149, including: (i) $34,551 for trade and accrued payables, (iv) $48,074 in accrued interest, and (iv) $334,032 for the continued accrual of unpaid wages and related expenses for all employees.

Our revenue generating activities during the period, as in previous years, have not produced sufficient funds for profitable operations, and we have incurred operating losses since inception. Accordingly, we have continued to utilize the cash raised in our financing activities to fund our operations. In addition to raising cash through additional financing activities, we may supplement our future working capital needs through the extension of trade payables and increases in accrued expenses. In view of these matters, realization of certain of the assets in the accompanying balance sheet is dependent upon our continued operations, which in turn is dependent upon our ability to meet our financial requirements, raise additional financing, and the success of our future operations.

Other Liabilities

2014 Short-Term Promissory Notes

During 2014, the Company issued eight promissory notes to six accredited investors in the aggregate principal amount of $68,000. Although the notes are non-interest bearing, as consideration to the note holders, the Company shall pay a total premium of 50% (total payment due of 1.5 times principal) of such notes, and the entire unpaid principal and premium amounts shall become immediately due on or before September 30, 2014, and January 31, 2015. All such notes were subsequently amended to extend their maturity date to December 31, 2015. If such notes are not paid by their original maturity date, then the Company shall pay a total premium of 100% (total payment due of 2 times principal), and such payments of total principal and premium amounts shall be from net revenue of future TBDx™ sales. Of the initial 50% premium, or $34,000, $23,020 was recorded as interest expense through the period ending December 31, 2014, and $10,980 shall be recorded in fiscal 2015. The additional 50% premium, or $34,000, shall be recorded as interest expense upon the Company achieving net revenue from future sales of TBDx™.

2013 Short-Term Promissory Notes

During 2013, the Company issued nine promissory notes to eight accredited investors in the aggregate principal amount of $179,500 ($179,275, net of commissions and expenses in the amount of $225), of which five notes for an aggregate of $48,500 originally matured during 2013, $14,000 matured on April 25, 2014, $100,000 matured on September 21, 2014, and $17,000 matured on October 25, 2014. All such notes were subsequently amended to extend their maturity date to December 31, 2015. The terms of the notes are essentially the same as the 2011 and 2012 short-term promissory notes, except that $40,000 of the notes accrue interest at a rate of 12% per annum, one note for $8,500 was noninterest bearing during 2013 and accrues interest at a rate of 10% effective January 1, 2014, one note for $14,000 accrues interest at a rate of 10% per annum, one note for $8,500 accrues interest at a rate of 5.9%, with two notes for $108,500 being noninterest bearing. Consideration for one $8,500 noninterest bearing note during 2013 received a modification to 540,000 warrants to include a cashless provision, one note of $8,500 received an extension of 4,632,725 warrants to December 31, 2018, and one for $100,000 received a 2% royalty payment of future TBDx™ net revenue in South Africa up to $300,000. The Company issued to six of the note holders an aggregate of 450,000 shares of common stock, and the relative fair value of the common stock of $31,100 will be amortized over the term of the notes.

2012 Short-Term Promissory Notes

During 2012, the Company issued six promissory notes to four accredited investors in the aggregate principal amount of $160,000. The twelve-month notes accrue interest at a rate of 12% per annum. Subsequently, the promissory notes have been amended to mature on December 31, 2015. The Company also issued to the note holders an aggregate of 285,000 shares of common stock. The

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relative fair value of the common stock of $11,715 will be amortized over the term of the notes. The Company also issued 10,800 shares of common stock as compensation in connection with the financing for a fair value of $2,700.

2011 Short-Term Promissory Notes

During October and November 2011, the Company issued two promissory notes to accredited investors in the aggregate principal amount of $400,000. The twelve-month notes accrue interest at a rate of 12% per annum. Subsequently, the promissory notes have been amended to mature on December 31, 2015. The Company also issued to the two note holders an aggregate of 400,000 shares of common stock. The relative fair value of the common stock of $34,700 will be amortized over the term of the notes. The Company also issued 250,000 shares of common stock as compensation in connection with the financing for a fair value of $25,000.

2006 through 2013 Short-Term Promissory Notes, Related Party

On October 18, 2006, the Company entered into a Loan Agreement with Mr. Michael W. Trudnak, our former deceased Chairman and Chief Executive Officer pursuant to which Mr. Trudnak loaned the Company $100,000. The Company issued a non-negotiable promissory note, dated effective October 18, 2006, to Mr. Trudnak in the principal amount of $100,000. The note is unsecured, non-negotiable and non-interest bearing. The note is repayable on the earlier of (i) six months after the date of issuance, (ii) the date the Company receives aggregate proceeds from the sale of its securities after the date of the issuance of the Note in an amount exceeding $2,000,000, or (iii) the occurrence of an event of default. The following constitute an event of default under the note: (a) the failure to pay when due any principal or interest or other liability under the loan agreement or under the note; (b) the material violation by us of any representation, warranty, covenant or agreement contained in the loan agreement, the note or any other loan document or any other document or agreement to which the Company is a party to or by which the Company or any of our properties, assets or outstanding securities are bound; (c) any event or circumstance shall occur that, in the reasonable opinion of the lender, has had or could reasonably be expected to have a material adverse effect; (d) an assignment for the benefit of our creditors; (e) the application for the appointment of a receiver or liquidator for us or our property; (f) the issuance of an attachment or the entry of a judgment against us in excess of $100,000; (g) a default with respect to any other obligation due to the lender; or (h) any voluntary or involuntary petition in bankruptcy or any petition for relief under the federal bankruptcy code or any other state or federal law for the relief of debtors by or with respect to us, provided however with respect to an involuntary petition in bankruptcy, such petition has not been dismissed within 30 days of the date of such petition. In the event of the occurrence of an event of default, the loan agreement and note shall be in default immediately and without notice, and the unpaid principal amount of the loan shall, at the option of the lender, become immediately due and payable in full. The Company agreed to pay the reasonable costs of collection and enforcement, including reasonable attorneys’ fees and interest from the date of default at the rate of 18% per annum. The note is not assignable by Mr. Trudnak without our prior consent. The Company may prepay the note in whole or in part upon ten days notice. On November 10, 2006, Mr. Trudnak extended the due date of the note to May 31, 2007. Mr. Trudnak made an additional $24,000 loan to the company on June 25, 2008, and $5,000 on September 14, 2011, for cumulative outstanding loans of $129,000. The maturity date of the outstanding loans was extended multiple times during 2009 through 2014. On December 31, 2014, the outstanding loans were extended to December 31, 2015. The Company repaid an aggregate of $6,900 of the notes during 2010, an aggregate $33,100 during 2011, an aggregate of $8,500 during 2013, resulting in an outstanding balance at June 30, 2015 of $80,500. The terms of the above transaction were reviewed and approved by the Company’s audit committee and by the independent members of our Board of Directors. Upon the death of Mr. Trudnak on April 18, 2014, the notes became part of his estate and assigned to his spouse, Jean M. Trudnak.

2006 and 2007 Series A Debentures (as Amended on October 15, 2010)

Under a securities purchase agreement, dated November 3, 2006, between the Company and certain institutional accredited investors, the Company sold an aggregate of $5,150,000 in principal amount of our Series A Debentures and Series D Common Stock Purchase Warrants to purchase an aggregate of 4,453,709 shares of our common stock. On November 8, 2006, the Company issued to the institutional investors an aggregate of $2,575,000 in principal amount of Series A Debentures and 4,453,709 Series D Warrants. On April 12, 2007, the Company issued an additional $2,575,000 in principal amount of the Series A Debentures, which followed the effectiveness of a registration statement registering the shares of our common stock underlying the Series A Debentures and Series D Warrants. Proceeds of the two offerings were used for the purpose of new personnel, research and development, registration expenses, for general working capital purposes, and repaying $200,000 in loans made to us by Mr. Michael W. Trudnak, our Chairman and CEO. The Company allocated proceeds from each closing to the derivative liability features of the Series A Debentures and Series D Warrants that were recognizable as a liability under generally accepted accounting principles. We also issued at the first closing an aggregate of 623,520 common stock purchase warrants to the placement agent as compensation in the offering, which were upon terms substantially similar to the Series D Warrants. One-half of the Series D Warrants (2,226,854 warrants) and the placement agent warrants (311,760 warrants) became exercisable on November 8, 2006. The remaining one-half of the Series D Warrants (2,226,855 warrants) and the placement agent warrants (311,760 warrants) became exercisable on April 12, 2007. The Series D Warrants and the placement agent’s warrants may be exercised via a cashless exercise if certain conditions are met. Due to the potential of the milestone-related adjustments, the initial exercise price of $1.15634 may be reset and the maximum number of shares to be issued under the debentures was at that time indeterminable, and the Company considered the guidance of ASC 815-40, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock”, whereby public companies that are

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or could be required to deliver shares of common stock as part of a physical settlement or a net-share settlement, under a freestanding financial instrument, are required to initially measure the contract at fair value, and concluded that the potential of the milestone-related adjustments at that time may cause insufficient shares to share settle the contracts. On April 1, 2007, due to the various milestone-related provisions, the conversion price of the Series A Debentures and the exercise price of the Series D Warrants and Placement Agent’s Warrants were reset to a price of $0.7453 per share, then to $0.6948 effective October 1, 2007, and the final milestone reset of $0.4089 effective April 1, 2008. The Series A Debentures and Series D Warrants also have a fully ratchet anti-dilution provision, whereby any subsequent equity transaction entitling a person to acquire shares of common stock at an effective price per share that is lower than the then conversion price, then the conversion price of the Debentures and Warrants shall be reduced to equal the lower subsequent equity transaction price. Subsequently, as a result of a June 2009 financing in which the Company elected to issue shares of common stock and warrants at $0.25 per share, the conversion price of our debentures and the exercise price of the Series D Warrants was adjusted under the anti-dilution provisions of such instruments to a price of $0.25 per share, and the number of shares underlying the Series D Warrants (including the warrants the Company issued to the placement agent in the financing) were increased by an aggregate of 2,677,417 Series D warrants. On July 10, 2007, a debenture holder exercised 864,798 Series D Warrants for 864,798 shares of common stock, and 914,798 warrants were exercised during 2010 under the cashless provision for 420,166 shares of common stock. Of the remaining Series D Warrants and Placement Agent Warrants, 3,062,527 warrants expired on November 11, 2011, and 3,012,523 warrants expired on April 12, 2012.

As of June 30, 2015, an aggregate of $3,461,795 in principal amount of the Series A Debentures have been converted into 8,730,037 shares of common stock, an aggregate of $663,043 in interest amount have been converted into 2,675,576 shares of common stock, and an aggregate of 1,779,596 Series D Warrants have been exercised resulting in the issuance of 1,284,964 shares of common stock. Accordingly, as of June 30, 2015, an aggregate of $1,688,205 of principal amount of the debentures remain unconverted.

Our outstanding Series A 10% Convertible Debentures originally became due on November 7, 2008. On October 15, 2010, we entered into an agreement with our two remaining Series A Debenture holders to amend and effect a restructuring of the debentures that originally became due on November 7, 2008. Under the amendment agreement, the Company and two debenture holders agreed: (i) to an extension of the maturity date of the debentures to June 30, 2011, (ii) that the $1,688,205 of outstanding principal amount will not bear interest from July 1, 2010 through the new maturity date, (iii) that, in exchange for the payment in cash of amounts of accrued but unpaid regular interest of approximately $638,163, and waived all additional interest and late fees, liquidated damages and certain other amounts due under the debentures (“Interest and Default Amounts”) the Company issued an aggregate of 2,552,653 shares of common stock, (iv) that all claims with regard to the payment of the Interest and Default Amounts and all prior events of default under the Debentures and breaches of any covenant, agreement, term or condition (“Defaults”) under our debentures and debenture transaction documents would be waived and the Company was released from any claims with respect to the Additional Interest and Late Fees of approximately $773,314, and Default Amounts of approximately $2,541,739, and prior Defaults Events, (v) to terminate the registration rights agreements between the Company and each debenture holder, and (vi) that the Company may force a conversion of the debentures if our common stock equals or exceeds certain price and volume conditions. There were no conversions of our debentures during 2014 or the six months ended June 30, 2015.

Under the Debenture amendment agreement, the Debenture holders agreed, commencing March 3, 2011, that the Company may force a conversion of the Debentures. Such a forced conversion may only be effected once every 90 days and the ability of the Company to force any such conversion is subject to certain equity conditions, which conditions were amended under the terms of the Debenture Amendment Agreement in accordance with the following:

·

if the variable weighted average price for the Company’s common stock (“VWAP”) for any five consecutive trading days exceeds $0.50 and the average daily dollar trading volume for the Company’s common stock during such period equals or exceeds $50,000, the Company may require a Holder to convert up to 25% of the outstanding principal amount of its Debenture on September 3, 2010, plus any liquidated damages or other amounts owing under the Debenture;

·

if the VWAP for any five consecutive trading days exceeds $0.75 and the average daily dollar trading volume for the common stock during such period equals or exceeds $75,000, the Company may require a Holder to convert up to an additional 25% of the outstanding principal amount of its Debenture on September 3, 2010, plus any liquidated damages or other amounts owing under the Debenture;

·

if the VWAP for any five consecutive trading days exceeds $1.00 and the average daily dollar trading volume for the common stock during such period equals or exceeds $100,000, the Company may require a Holder to convert up to 100% of the outstanding principal amount of its Debenture on September 3, 2010, plus any liquidated damages or other amounts owing under the Debenture.

The principal amount of our outstanding Series A Debentures of $1,688,205 became due on July 1, 2011, and such amount was not paid. Therefore, the Company could be considered in default and may result in enforcement of the debenture holders’ rights and remedies under the debentures and applicable law. We have been in discussions with the debenture holders to re-negotiate the terms of the debentures, including the repayment or repurchase of the debentures and/or seek to extend their maturity date, although we have not reached any agreement with the debenture holders with regard to any such repayment, repurchase or extension. Our ability to repay or repurchase the debentures is contingent upon our ability to raise additional financing, of which there can be no assurance. Also, as a condition to any such extension, debenture holders may seek to amend or modify certain other terms of the debentures.

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When an event of default occurs under the debentures, the debenture holders may elect to require us to make immediate repayment of the mandatory default amount, which equals the sum of (i) the greater of either (a) 120% of the outstanding principal amount of the debentures, or (b) the outstanding principal amount unpaid divided by the conversion price on the date the mandatory default amount is either (1) demanded or otherwise due or (2) paid in full, whichever has the lower conversion price, multiplied by the variable weighted average price of the common stock on the date the mandatory default amount is either demanded or otherwise due, whichever has the higher variable weighted average price, and (ii) all other amounts, costs, expenses, and liquidated damages due under the debentures. In anticipation of such election by the debenture holders, due to the nonpayment of principal amount on the due date of July 1, 2011, we measured the mandatory default at approximately $337,641 and subsequently on each balance sheet date, which is reflected in the carrying value of the debentures and also recognized as interest expense. We remeasured the mandatory default amount as of June 30, 2015 at approximately $337,641. As of the date of this report, the debenture holders have not made an election requiring immediate repayment of the mandatory amount, although there can be no assurance they will not do so. The Company currently has insufficient funds to repay the outstanding amount in the event the debenture holders make a demand for payment.

Prior to the Debenture amendment agreement and absent a default, the Debentures bore interest at the rate of 10% per annum. The Debenture agreement, as amended on October 15, 2010, states no interest and that from July 1, 2010 through the maturity date of June 30, 2011, the principal amount of this Debenture shall bear no interest.” Any reference to the accrual of interest or late fees, beyond the maturity date, was specifically deleted from the Debenture agreement. If an Event of Default occurs, the outstanding principal amount of the Debentures, plus accrued but unpaid interest, liquidated damages and other amounts owing in respect thereof through the date of acceleration, shall become, at the holder’s election, immediately due and payable in cash at the mandatory default amount. Commencing 5 days after the occurrence of any Event of Default that results in the eventual acceleration of the Debenture, the interest rate on the Debenture shall accrue at an interest rate equal to the lessor of 18% per annum or the maximum rate permitted under applicable law. In accordance with the terms of the amendment agreement, management believes there is no legal requirement to continue the accrual of interest or late fees. Management also determined that there are two (2) events that must take place before the default interest rate of 18% takes effect. One is an event of default, which occurred when the Company did not make payment of the outstanding principle amount on the amended due date of July 1, 2011. The other event is an “eventual acceleration” of the mandatory default amount, which did not take place since the default did not occur before the maturity date of June 30, 2011, and the event of default occurred on the due date of July 1, 2011 when payment was not made by the Company. Since the default did not take place before the maturity or due date, no acceleration of the payment for the outstanding principal amount of the Debentures took place, and the 18% default interest provision does not apply.

The Debenture agreement, as amended on October 15, 2010, continues to permit the payment of interest, if due, in cash or registered shares of our common stock. If we elected to pay the interest due in shares of our common stock, the number of shares to be issued in payment of interest is determined on the basis of 85% of the lesser of the daily volume weighted average price of our common stock as reported by Bloomberg LP (“VWAP”) for the five trading days ending on the date that is immediately prior to (a) date the interest is due or (b) the date such shares are issued and delivered to the holder. We could pay interest in shares of our common stock only if the equity conditions, described below, have been met during the 20 consecutive trading days prior to the date the interest is due and through the date the shares are issued. The payment of interest in shares of our stock, the redemption of the Debentures and the occurrence of certain other events, was subject to a requirement that certain equity conditions (“equity conditions”) were met, as follows: (i) we have honored all conversions and redemptions of a Debenture by the holder, (ii) we have paid all liquidated damages and other amounts due to the holder, (iii) the registration statement covering the resale of the shares underlying the Debentures and Series D Warrants is effective permitting a holder to utilize the registration statement to resell its shares, (iv) our stock is traded on the OTC Markets, OTCQB or other securities exchange and all of the shares upon conversion or exercise of the Debentures and Series D Warrants are listed for trading, (v) we have sufficient authorized but unreserved shares of our common stock to cover the issuance of the shares upon conversion or exercise of the Debentures and Series D Warrants, (vi) there is no event of default under the Debentures, (vii) the issuance of the shares would not violate a holder’s 4.99% or 9.99% ownership restriction cap, (viii) we have not made a public announcement of a pending merger, sale of all of our assets or similar transaction or a transaction in which a greater than 50% change in control of the Company may occur and the transaction has not been consummated, (ix) the holder is not in possession of material public information regarding us, and (x) the daily trading volume of our shares for 20 consecutive trading days prior to the applicable date exceeds 100,000 shares. Under the terms of the Debenture Amendment Agreement, (A) the equity condition in (iii) above was amended to provide that such condition is met if, in the alternative, the shares issuable upon conversion of the Debentures may then be resold pursuant to Rule 144 without restriction or limitation and the Company has delivered to a holder an opinion of the Company’s counsel that such resale may legally be made and provided the holder has furnished a representation letter reasonable acceptable to the Company’s counsel that the holder is not an “affiliate” for purposes of Rule 144; (B) the equity condition in (vi) above was amended to except an event of default that has previously been waived; and (C) the equity condition in (x) above was amended to except circumstances where another volume condition is applicable.

The Debentures contain a limitation on the amount of Debenture that may be converted at any one time in the event the holder owns beneficially more than 4.99% of our common stock without regard to the number of shares underlying the unconverted portion of the Debenture. This limitation may be waived upon 61 days’ notice to us by the holder of the Debenture permitting the holder to change such limitation to 9.99%.

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An event of default may occur under the Debentures if (a) the Company defaults in the payment of principal or, liquidated damages , (b) the Company fails to materially observe or perform a covenant or agreement in the Debentures, (c) a default or event of default occurs under any other transaction document related to the financing or in any other material agreement to which the Company is a party that results in a material adverse effect on the Company, (d) any representation or warranty the Company made to investors in the transaction documents related to the financing is materially untrue or incorrect, (e) a bankruptcy event occurs with regard to the Company, (f) the Company defaults on any other loan, mortgage, or credit arrangement that involves an amount greater than $150,000 and results in the obligation becoming declared due prior to the due date, (g) the Company’s common stock is not eligible for quotation on the OTC Markets or other exchange on which the Company’s shares are traded, (h) a transaction occurs in which the control of the Company changes, the Company effects a merger or consolidation, the Company sells substantially all of the assets, a tender offer is made for the Company’s shares, the Company reclassify their shares or a compulsory share exchange, or the Company agrees to sell more than 33% of the assets, unless the Company receives the consent of holders of 67% of then outstanding principal of the Company’s Debentures, (i) the Company fails to deliver certificates for shares to be issued on conversion within seven trading days, (j) the Company has a judgment against it for more than $150,000. We have agreed to compensate a holder of a Debenture in the event our transfer agent fails to deliver shares upon conversion of the Debentures within three trading days of the date of conversion, and the holder’s broker is required to purchase shares of our common stock in satisfaction of a sale by a holder.

The conversion price of the Debentures or the number of shares to be issued upon conversion or exercise of the Debentures are subject to adjustment in the event of a stock dividend, stock split, subdivision or combination of our shares of common stock, reclassification, sales of our securities below their then conversion or exercise price (“subsequent equity sales anti-dilution adjustment provisions”), a subsequent rights offering, or a reclassification of our shares. Also, if we effect a merger or consolidation with another company, we sell all or substantially all of our assets, a tender offer or exchange offer is made for our shares, or we effect a reclassification of our shares or a compulsory share exchange, a holder that subsequently converts its Debenture will be entitled to receive the same kind and amount of securities, cash or property as if the shares it is entitled to receive on the conversion had been issued and outstanding on the date immediately prior to the date any such transaction occurred. Except as discussed above, no such events have occurred through the date of this report.

We were not required to make an adjustment to the conversion or exercise price or the number of shares to be issued upon conversion or exercise of the Debentures pursuant to the subsequent equity sales anti-dilution adjustment provisions related to an “exempt issuance,” which is defined as: (A) any stock or options that are issued under our stock option plans or are approved by a majority of non-employee directors and issued (i) to employees, officers or directors or (ii) to consultants, but only if the amount issued to consultants does not exceed 400,000 shares in a 12 month period, (B) securities issued under the Debentures, (C) shares of common stock issued upon conversion or exercise of, or in exchange for, securities outstanding on the date we entered into the securities purchase agreement, or (D) the issuance of securities in an acquisition or strategic transaction approved by our disinterested directors. Under the Debenture Amendment Agreement, commencing October 15, 2010, Debenture holders agreed that an “exempt issuance” shall also include the issuance of stock or common stock equivalents authorized and approved in advance by the Company’s disinterested directors at a price per share or at a conversion or exercise price per share equal to or greater than $0.25.

In connection with our Series A Debenture financing, we entered into a registration rights agreement with purchaser of our debentures pursuant to which we agreed we would use our best efforts to file a registration statement under the Securities Act within 45 days of the first closing to permit the public resale by debenture holders of the shares that may be issued upon conversion of the Debentures and upon exercise of the Series D Warrants, including the shares of our common stock underlying the Debentures to be issued at the second closing. Pursuant to the amendments we entered into with the current debenture holders on October 15, 2010, the debenture holders agreed to terminate their registration rights agreements with us. Accordingly, we are not required to register or maintain the registration of the shares underlying the Series A Debentures, however, the Company was obligated under the terms of the Registration Rights Agreement that the Company entered into with each purchaser that has fully converted its Debenture.

We also granted to each purchaser of the Debentures the right to participate in any offering by us of common stock or common stock equivalents until the later of (i) 12 months after the effective date of the registration statement and (ii) the date a purchaser holds less than 20% of the principal amount of the Debenture the purchaser originally agreed to purchase, except for an exempt issuance or an underwritten public offering of our common stock. Purchasers may participate in such an offering up to the lesser of 100% of the future offering or the aggregate amount subscribed for under the securities purchase agreement by all purchasers. Although such common stock offerings have occurred, the Debenture holders have notified the Company that they do not want to participate in any future financings.

The securities purchase agreement also contained representations and warranties of both us and purchasers, conditions to closing, certain indemnification provisions, and other customary provisions. Also the Debenture Amendment Agreement amended certain provisions covering events of default under the Debentures, contained certain representations and warranties of the Company, a reaffirmation of certain of the representations and warranties in the securities purchase agreement, contained certain conditions to closing, and certain other customary provisions. We were prohibited from effecting a reverse or forward stock split or reclassification of our common stock except as may be required to comply with the listing standards of any national securities exchange.

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The Company had interest expense of $48,074, and $43,358, for the six months ended June 30, 2015, and the same period in 2014, respectively. Debt discount amortization costs of $0, and $15,541, for the six months ended June 30, 2015, and the same period in 2014, respectively

Additional Capital

To the extent that additional capital is raised through the sale of our equity or equity-related securities of our subsidiaries, the issuance of our securities could result in dilution to our stockholders. No assurance can be given that we will have access to the capital markets in the future, or that financing will be available on terms acceptable to satisfy our cash requirements, implement our business strategies, and meet the restrictive requirements of the debenture financing described above. If we are unable to access the capital markets or obtain acceptable financing, our results of operations and financial condition could be materially and adversely affected. We may be required to raise substantial additional funds through other means. We have not begun to receive material revenues from our commercial operations associated with the software products. Management may seek to raise additional capital through one or more equity or debt financings or have discussions with certain investors with regard thereto. We cannot assure our stockholders that our technology and products will be commercially accepted or that revenues will be sufficient to fund our operations. If adequate funds are not available to us, we may be required to curtail operations significantly or to obtain funds through entering into arrangements with collaborative partners or others that may require us to relinquish rights to certain of our technologies or products.

Off-Balance Sheet Arrangements

We do not maintain any off-balance sheet arrangements, transactions, obligations or other relationships with unconsolidated entities that would be expected to have a material current or future effect upon our financial condition, or results of operations as of June 30, 2015 and December 31, 2014.

Financial Condition, Going Concern Uncertainties and Events of Default

The Company, previously an operating stage company, became a development stage company on April 1, 2012. A development stage company, as defined by ASC-915-10 “Accounting and Reporting by Development Stage Enterprise”, is an entity that devotes substantially all of its efforts to establish a business and either of the following conditions exists: 1) the principal operations have not commenced, or 2) the principal operations have commenced, but there has been no significant revenue therefrom. During 2015, Applied Visual Sciences’ revenue generating activities have not produced sufficient funds for profitable operations and we have incurred operating losses since inception. In view of these matters, realization of certain of the assets in the accompanying consolidated balance sheet is dependent upon continued operations, which in turn is dependent upon our ability to meet our financial requirements, raise additional financing on acceptable terms, and the success of future operations. Our independent registered public accounting firm’s report on the consolidated financial statements included herein, and in this Annual Report on Form 10-K for the year ended December 31, 2014, contains an explanatory paragraph wherein they expressed an opinion that there is substantial doubt about our ability to continue as a going concern. Accordingly, careful consideration of such opinion should be given in determining whether to continue or become our stockholder. In addition, the Company is currently evaluating the impact of ASU No. 2014-15, Presentation of Financial Statements—Going Concern, on its disclosures regarding the Company’s ability to continue as a going concern.

As of June 30, 2015, the Company has outstanding trade and accrued payables of $1,826,743, other accrued liabilities of $290,478, and accrued salaries and related expenses due to our employees and management of $9,126,140. Also, the Company has an outstanding noninterest-bearing loan from its previous Chief Executive Officer of $80,500, and $807,500 short-term notes from a total of twenty (20) investors.

The principal amount of our outstanding Series A Debentures of $1,688,205 became due on July 1, 2011, and such amount was not paid. Therefore, the Company could be considered in default and may result in enforcement of the debenture holders’ rights and remedies under the debentures and applicable law. We have been in discussions with the debenture holders to re-negotiate the terms of the debentures, including the repayment or repurchase of the debentures and/or seek to extend their maturity date, although we have not reached any agreement with the debenture holders with regard to any such repayment, repurchase or extension. Our ability to repay or repurchase the debentures is contingent upon our ability to raise additional financing, of which there can be no assurance. Also, as a condition to any such extension, debenture holders may seek to amend or modify certain other terms of the debentures. When an event of default occurs under the debentures, the debenture holders may elect to require us to make immediate repayment of the mandatory default amount, which equals the sum of (i) the greater of either (a) 120% of the outstanding principal amount of the debentures, or (b) the outstanding principal amount unpaid divided by the conversion price on the date the mandatory default amount is either (1) demanded or otherwise due or (2) paid in full, whichever has the lower conversion price, multiplied by the variable weighted average price of the common stock on the date the mandatory default amount is either demanded or otherwise due, whichever has the higher variable weighted average price, and (ii) all other amounts, costs, expenses, and liquidated damages due under the debentures. In anticipation of such election by the debenture holders, due to the nonpayment of principal amount on the due date of July 1, 2011, we measured the mandatory default at approximately $337,641 and subsequently on each balance sheet date, which is reflected in the carrying value of the debentures and also recognized as interest expense. We remeasured the mandatory

37

default amount as of June 30, 2015 at approximately $337,641. As of the date of this report, the debenture holders have not made an election requiring immediate repayment of the mandatory amount, although there can be no assurance they will not do so. The Company currently has insufficient funds to repay the outstanding amount in the event the debenture holders make a demand for payment.

As of June 30, 2015, we had a cash balance of $18,484. Management believes these funds to be insufficient to fund our operations for the next twelve months absent any cash flow from operations or funds from the sale of our equity or debt securities. Currently, will require an aggregate of approximately we are spending or incurring (and accruing) expenses of approximately $150,000 per month on operations and the continued research and development of our 3i technologies and products, including with regard to salaries and consulting fees. Management believes that we will require an aggregate of approximately $1,800,000 to fund our operations for the next 12 months and to repay certain outstanding trade payables and accrued expenses. This assumes that holders of our outstanding debentures convert such debt into shares of our common stock or that we are able to extend the term of the debentures, of which there can be no assurance. In the event we are unable to extend the term of the debentures beyond their new maturity date, the debenture holders do not convert such debt or require payment of principal, partially convert such debt, or effect the buy-in provision related to the debentures, we shall be required to raise additional financing. Also, this assumes that we are able to continue to defer the amounts due to our employees for accrued and unpaid salaries and that we are able to continue to extend or defer payment of certain amounts due to our trade creditors, of which there can be no assurance.

The Company has relied and continues to rely substantially upon equity and debt financing to fund its ongoing operations, including the research and development conducted in connection with its products and conversion of accounts payable for stock. The proceeds from our financings have been and continue to be insufficient to fund our operations, pay our trade payables, and repay our unconverted debentures or accrued and unpaid wages to our employees. Therefore, the debentures holders, our employees, or trade creditors may seek to enforce payment of amounts due to them, and our results of operations and financial condition could be materially and adversely affected and we may be unable to continue our operations. Also, in the event we continue to be unable to pay our employees, we may suffer further employee attrition. There can be no assurances that we will be successful in our efforts to raise any additional financing, any bank borrowing, and research or grant funding. Moreover, in view of the current market price of and limited trading volume in our stock, we may have limited or no access to the capital markets. Furthermore, under the terms of our agreements with the debenture holders, we are subject to restrictions on our ability to engage in any transactions in our securities in which the conversion, exercise or exchange rate or other price of such securities is below the current conversion price or is based upon the trading price of our securities after initial issuance or otherwise subject to re-set. In view of the foregoing, we may be required to curtail operations significantly, or obtain funds through entering into arrangements with collaborative partners or others that may require us to relinquish rights to certain of our technologies or products.

During the six months ended June 30, 2015, our total stockholders’ deficit increased by $299,319 to $13,870,115, and our consolidated net loss for the period was $359,319, compared to a net loss for the same period in 2014 of $304,524, or a decrease of $54,795 (18.0%). Notwithstanding the foregoing discussion of management’s expectations regarding future cash flows, Applied Visual Sciences’ insolvency continues to increase the uncertainties related to its continued existence. Both management and the Board of Directors are carefully monitoring the Company’s cash flows and financial position in consideration of these increasing uncertainties and the needs of both creditors and stockholders.

Significant Accounting Policies

The preparation of the Company’s financial statements requires management to make estimates, judgments, and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses during the periods presented. The Company, previously an operating stage company, became a development stage company on April 1, 2012. A development stage company, as defined by ASC-915-10 “Accounting and Reporting by Development Stage Enterprise”, is an entity that devotes substantially all of its efforts to establish a business and either of the following conditions exists: 1) the principal operations have not commenced, or 2) the principal operations have commenced, but there has been no significant revenue therefrom. Also, the FASB issued ASU No. 2014-15, Presentation of Financial Statements—Going Concern. The provisions of ASU No. 2014-15 require management to assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. The amendments in ASU 2014-15 are effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. The Company is currently assessing the impact of this ASU on the Company’s consolidated financial statements.

For a discussion of the Company’s critical accounting policies and estimates, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. Except as disclosed in Part I, Item 4, Controls and Procedures of this report, and in Note 2 of our 2014 Form 10-K, there have been no material changes to these critical accounting policies that impacted the Company’s reported amounts of assets, liabilities, revenues or expenses during the six-month period ended June 30, 2015.

38

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

Our market risk is confined to changes in foreign currency exchange rates and potentially adverse effects of differing tax structures. There were no international revenues subject to such market risks during the six-month period ended June 30, 2015, although,, we may be exposed to foreign exchange rate fluctuations as the Company pursues revenue opportunities outside the United States. As exchange rates vary, results when translated may vary from expectations and adversely impact overall expected profitability. As of June 30, 2015, the Company’s foreign currency exposure is related to accounts payable trade in the amount of $30,371.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this Report, the Chief Executive Officer and Chief Financial Officer of the Company (the “Certifying Officers”) conducted evaluations of the Company’s disclosure controls and procedures. As defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the term “disclosure controls and procedures” means controls and other procedures of an issuer that are designed to ensure the information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s (“SEC”) rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including the Certifying Officers, to allow timely decisions regarding required disclosure.

Based on this evaluation, and for reasons discussed below, the Certifying Officers determined that, as of the end of the period covered by this Report, the Company’s disclosure controls and procedures were not effective to ensure that the information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and to ensure that information required to be disclosed by the Company in the Reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including the Company’s principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding disclosure. On July 17, 2015, the Company filed its Annual Report on Form 10-K for the year ended December 31, 2014, which was due on March 31, 2015. Also, on August 6, 2015, the Company filed its Quarterly Report on Form 10-Q for the period ended March 31, 2015, which was due on May 15, 2015.

Although the Certifying Officers have determined that our disclosure controls and procedures were not effective, management continues to believe that a refinement to our disclosure controls is an ongoing process. The Audit Committee believes the Company should continue the following activities: (a) additional education and professional development for the Company’s accounting and other staff on new and existing applicable SEC filing requirements, certain applicable SEC disclosure requirements, and the timing of the filing thereof, and (b) reviewing disclosure requirements, including Form 10-K and Regulation S-K disclosure requirements, SEC staff guidance and interpretations related thereof, as well as Accounting Standards Codification (“ASCs”) and updates.

Changes in Internal Controls

There were no changes in the Company’s internal controls over financial reporting during the period covered by the Report that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

None

ITEM 1A. RISK FACTORS

An investment in our common stock involves a high degree of risk. You should carefully consider the risks described below (which reflect changes to certain of the risk factors we disclosed in our 2014 Form 10-K) and other information contained in this Report in deciding whether to invest in our common stock, as well as certain risk factors set forth under Part I, Item 1A of our 2014 Form 10-K. Additional risks not presently known to us or which we currently consider immaterial may also adversely affect our company. If any of the following risks actually occur, our business, financial condition and operating results could be materially adversely affected. In such case, the trading price of our common stock could decline, and you could lose a part of your investment.

Risks Related to Our Company and Our Operations

39

We have incurred substantial debt which could affect our ability to obtain additional financing and may increase our vulnerability to business downturns. We may be unable to repay our Series A Debentures that matured on June 30, 2011.

As of June 30, 2015, the aggregate principal under our outstanding Series A Debentures was $1,688,205, which matured on June 30, 2011. Also, we have outstanding trade and accrued payables of $1,826,743, other accrued liabilities of $290,478, and accrued salaries due to our employees and management of $8,461,511, as well as accrued related payroll liabilities of $664,629. Also, the Company has an outstanding noninterest-bearing loan from its former deceased Chief Executive Officer of $80,500, and $807,500 short-term notes from twenty (20) investors. We are subject to the risks associated with substantial indebtedness, including insufficient funds to repay the outstanding principal in the event the debenture holders make a demand for payment; it may be more expensive and difficult to obtain additional financing; and we are more vulnerable to economic downturns.

We did not make timely payment of outstanding principal when due under our Series A Debentures, and failure to make such payment is an event of default under the debentures. We have insufficient cash resources to repay the amounts due to our debenture holders.

The principal amount of our outstanding Series A Debentures of $1,688,205 became due on July 1, 2011, and such amount was not paid. Therefore, the Company could be considered in default and may result in enforcement of the debenture holders’ rights and remedies under the debentures and applicable law. We are in discussions with the debenture holders to re-negotiate the terms of the debentures, including the repayment or repurchase of the debentures and/or seek to extend their maturity date, although we have not reached any agreement with the debenture holders with regard to any such repayment, repurchase or extension. Our ability to repay or repurchase the debentures is contingent upon our ability to raise additional financing, of which there can be no assurance. Also, as a condition to any such extension, debenture holders may seek to amend or modify certain other terms of the debentures. When an event of default occurs under the debentures, the debenture holders may elect to require us to make immediate repayment of the mandatory default amount, which equals the sum of (i) the greater of either (a) 120% of the outstanding principal amount of the debentures, or (b) the outstanding principal amount unpaid divided by the conversion price on the date the mandatory default amount is either (1) demanded or otherwise due or (2) paid in full, whichever has the lower conversion price, multiplied by the variable weighted average price of the common stock on the date the mandatory default amount is either demanded or otherwise due, whichever has the higher variable weighted average price, and (ii) all other amounts, costs, expenses, and liquidated damages due under the debentures. In anticipation of such election by the debenture holders, due to the nonpayment of principal amount on the due date of July 1, 2011, we measured the mandatory default at approximately $337,641 and subsequently on each balance sheet date, which is reflected in the carrying value of the debentures and also recognized as interest expense. We remeasured the mandatory default amount as of June 30, 2015 at approximately $337,641. As of the date of this report, the debenture holders have not made an election requiring immediate repayment of the mandatory amount, although there can be no assurance they will not do so. The Company currently has insufficient funds to repay the outstanding amount in the event the debenture holders make a demand for payment.

We have a severe working capital deficit and, in addition to proceeds from financings, we continue to have outstanding loans from our former deceased chief executive officer and deferrals of salaries by our executive officer, employees and a consultant/director. In the event we are unable to pay our employees salaries, we may experience employee attrition which could materially and adversely affect our business and operations.

During the six months ended June 30, 2015, our total stockholders’ deficit increased by $299,319 to $13,870,115, and our consolidated net loss for the period was $359,319, compared to a net loss for the same period in 2014 of $304,524, or a decrease of $54,795 (18.0%). Our revenue generating activities had not produced sufficient funds for profitable operations and we have incurred operating losses since inception. Although we have obtained limited cash from certain financings, we continue to have outstanding loans from our previous chief executive officer of approximately $80,500, accrued and unpaid salaries of our two named executive officers and previous chief executive officer in the amount of $4,981,468, and to other employees of $3,480,043, and outstanding accounts payable to a previous consultant/director of the Company in the amount of $888,248. The Company currently employs three full-time, one part-time employee, and during 2014 employed four full-time, and one part-time employee who assisted the Company upon request. The Company’s insolvency continues to increase the uncertainties related to its continued existence. Also, in the event we are unable to pay our employees, we may continue to experience further employee attrition which could materially adversely affect our business and operations, including our ongoing research and development activities. Both management and the Board of Directors are carefully monitoring the Company’s cash flows and financial position in consideration of these increasing uncertainties and the needs of both creditors and stockholders.

Our certifying officers evaluated the effectiveness of our disclosure controls and procedures, and concluded that our disclosure controls were not effective for the period ending June 30, 2015, and December 31, 2014, and that we had certain weaknesses during those periods in our internal controls over timely reporting. Therefore, internal controls over timely reporting were ineffective as of the period covered by this Report.

Our Chief Executive Officer and Chief Financial Officer (the “Certifying Officers”) are responsible for establishing and maintaining our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e) and 15d-15(e)). The Certifying Officers designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under their supervision, to

40

ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified by the SEC’s rules and forms, and is made known to management (including the Certifying Officers) by others within the Company, including its subsidiaries. We regularly evaluate the effectiveness of our disclosure controls and procedures and report our conclusions about the effectiveness of the disclosure controls quarterly in our Forms 10-Q and annually in our Forms 10-K. In completing such reporting, we disclose, as appropriate, any significant change in our internal control over financial reporting that occurred during our most recent fiscal period that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. On July 17, 2015, the Company filed its Annual Report on Form 10-K for the year ended December 31, 2014, which was due on March 31, 2015. Also, on August 6, 2015, the Company filed its Quarterly Report on Form 10-Q for the period ended March 31, 2015, which was due on May 15, 2015. Our Certifying Officers concluded that our disclosure controls and procedures were not effective as of the end of the period covered by such reports. Although the Certifying Officers have determined that our disclosure controls and procedures were not effective, management continues to believe that refinement to our disclosure controls and procedures is an ongoing progress. The Audit Committee believes the Company should continue the following activities: (a) additional education and professional development for the Company’s accounting and other staff on new and existing applicable SEC filing requirements, certain applicable SEC disclosure requirements, and the timing of the filing thereof, and (b) reviewing disclosure requirements, including Form 10-K and Regulation S-K disclosure requirements, SEC staff guidance and interpretations related thereto. While management is responsible for establishing and maintaining our disclosure controls and procedures and has taken steps to ensure that the disclosure controls are effective and free of “significant deficiencies” and/or “material weaknesses,” the ability of management to implement the remediation of such weaknesses and deficiencies and the inherent nature of our business and rapidly changing environment may affect management’s ability to be successful with this initiative.

Dilutive effect of conversion of Series A Senior Convertible Debentures, and the exercise of outstanding common stock purchase warrants, of which some carry a cashless exercise provision.

At June 30, 2015, an aggregate of 6,752,820 of our shares of our common stock issuable upon full conversion of our outstanding Series A Debentures. The Company also has an aggregate of 18,360,260 of our shares issuable upon exercise of outstanding common stock purchase warrants that have an average exercise price of $0.26, of which approximately 5,143,973 warrants may be exercised pursuant to the cashless exercise provisions of such warrants and may be subsequently resold as “restricted securities” under the provisions of Rule 144 under the Securities Act. Increased sales volume of the Company’s common stock could cause the market price of the Company’s common stock to drop. Sales of a substantial number of shares of our common stock in the public market, or the perception that these sales might occur, could depress the market price of our common stock and could impair our ability to raise capital through the sale of additional equity securities.

Our lease expired in January 2013 and was not be able to extend our existing lease, and elected not to obtain a lease for new office space because of our financial condition and limited cash resources.

The Company’s office lease for our principal executive offices expired on January 31, 2013. The lease did include a renewal provision, and due to our financial condition and limited cash, the Company was not able to renew the lease, and elected to not obtain a lease for office space due to terms that are unacceptable to us.

Our directors and named executive officers own a substantial percentage of our common stock.

As of August 19, 2015, our directors, executive officers and the estate of our previous chief executive officer beneficially owned approximately 27.8% of our shares of common stock. Accordingly, our directors, executive officers, the estate of our previous chief executive officer, and most highly compensated employee are entitled to cast an aggregate of 12,713,534 votes on matters submitted to our stockholders for a vote or approximately 11.9% of the total number of votes entitled to be cast at a meeting of our stockholders. These stockholders, if they acted together, could exert substantial control over matters requiring approval by our stockholders. These matters would include the election of directors and the approval of mergers or other business combination transactions. This concentration of ownership may discourage or prevent someone from acquiring our business.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

ITEM 3. DEFAULT UNDER OUR SERIES A DEBENTURES

The principal amount of our outstanding Series A Debentures of $1,688,205 became due on July 1, 2011, and such amount was not paid. Therefore, the Company could be considered in default and may result in enforcement of the debenture holders’ rights and remedies under the debentures and applicable law. We are in discussions with the debenture holders to re-negotiate the terms of the debentures, including the repayment or repurchase of the debentures and/or seek to extend their maturity date, although we have not reached any agreement with the debenture holders with regard to any such repayment, repurchase or extension. Our ability to repay or

41

repurchase the debentures is contingent upon our ability to raise additional financing, of which there can be no assurance. Also, as a condition to any such extension, debenture holders may seek to amend or modify certain other terms of the debentures. When an event of default occurs under the debentures, the debenture holders may elect to require us to make immediate repayment of the mandatory default amount, which equals the sum of (i) the greater of either (a) 120% of the outstanding principal amount of the debentures, or (b) the outstanding principal amount unpaid divided by the conversion price on the date the mandatory default amount is either (1) demanded or otherwise due or (2) paid in full, whichever has the lower conversion price, multiplied by the variable weighted average price of the common stock on the date the mandatory default amount is either demanded or otherwise due, whichever has the higher variable weighted average price, and (ii) all other amounts, costs, expenses, and liquidated damages due under the debentures. In anticipation of such election by the debenture holders, due to the nonpayment of principal amount on the due date of July 1, 2011, we measured the mandatory default at approximately $337,641 and subsequently on each balance sheet date, which is reflected in the carrying value of the debentures and also recognized as interest expense. We remeasured the mandatory default amount as of June 30, 2015 at approximately $337,641. As of the date of this report, the debenture holders have not made an election requiring immediate repayment of the mandatory amount, although there can be no assurance they will not do so. The Company currently has insufficient funds to repay the outstanding amount in the event the debenture holders make a demand for payment.

ITEM 5. OTHER INFORMATION

Not Applicable

ITEM 6. INDEX TO EXHIBITS

Copies of the following documents are included as exhibits to this report pursuant to Item 601 of Regulation S-K.


APPLIED VISUAL SCIENCES, INC.

INDEX TO EXHIBITS
Exhibit		Incorporated by Reference		Filed
Number	Description	Form	Filing Date	Herewith
31.1	Certification Pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (CEO)			X
31.2	Certification Pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (CFO)			X
32.1	Certification Pursuant Rule 13a-14(b) or Rule 15d-14(b) and 18 U.S.C. Section 906 of the Sarbanes-Oxley Act of 2002, As Amended (CEO)			X
32.2	Certification Pursuant Rule 13a-14(b) or Rule 15d-14(b) and 18 U.S.C. Section 906 of the Sarbanes-Oxley Act of 2002, As Amended (CFO)			X
101.INS	XBRL Instance Document *			X
101.SCH	XBRL Taxonomy Extension Schema Document *			X
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document *			X
101.LAB	XBRL Taxonomy Extension Definition Linkbase Document *			X
101.PRE	XBRL Taxonomy Extension Label Linkbase Document *			X
101.DEF	XBRL Taxonomy Extension Presentation Linkbase Document *			X

* Users of this data are advised pursuant to Rule 406T of Regulation S-X that this interactive data file is deemed not filed or part of a registration statement or prospectus for the purpose of section 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

42

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

APPLIED VISUAL SCIENCES, INC.

By: /s/ William J. Donovan

William J. Donovan

Chief Executive Officer

(Principal Executive Officer)

By: /s/ Gregory E. Hare

Gregory E. Hare

Chief Financial Officer

(Principal Financial and Accounting Officer)

Date: August 19, 2015

Exhibit 31.1

CERTIFICATION PURSUANT TO RULE 13a-14(a) OR 15d-14(a) UNDER THE SECURITIES
EXCHANGE ACT OF 1934, AS ADOPTED PURSUANT TO SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002, AS AMENDED

I, William J. Donovan, certify that:

1.

I have reviewed this Quarterly Report on Form 10-Q of Applied Visual Sciences, Inc.;

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.

The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)

Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

(a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 19, 2015

Signed:

/s/ William J. Donovan

Name:

William J. Donovan

Title:

Chief Executive Officer

Exhibit 31.2

CERTIFICATION PURSUANT TO RULE 13a-14(a) OR 15d-14(a) UNDER THE SECURITIES
EXCHANGE ACT OF 1934, AS ADOPTED PURSUANT TO SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002, AS AMENDED

I, Gregory E. Hare, certify that:

1.

I have reviewed this Quarterly Report on Form 10-Q of Applied Visual Sciences, Inc.;

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.

The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)

Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

(a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 19, 2015

Signed:

/s/ Gregory E. Hare

Name:

Gregory E. Hare

Title:

Chief Financial Officer

Exhibit 32.1

CERTIFICATION

PURSUANT TO RULE 13a-14(b) or

RULE 15d-14(b) AND 18 U.S.C. SECTION 1350
(AS ADOPTED PURSUANT TO SECTION 906 OF THE

SARBANES-OXLEY ACT OF 2002, AS AMENDED)

Pursuant to 18 U.S.C. Section 1350 (as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, as amended), the undersigned officer of Applied Visual Sciences, Inc., a Delaware corporation (the “Company”), does hereby certify, to such officer’s knowledge, that:

The Quarterly Report on Form 10-Q for the quarter ended June 30, 2015 (the “Report”) of the Company fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (15 U.S.C. 78m or 78o(d), and the information contained in the 10-K fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: August 19, 2015

Signed:

/s/ William J. Donovan

Name:

William J. Donovan

Title:

Chief Executive Officer

Exhibit 32.2

CERTIFICATION

PURSUANT TO RULE 13a-14(b) or

RULE 15d-14(b) AND 18 U.S.C. SECTION 1350
(AS ADOPTED PURSUANT TO SECTION 906 OF THE

SARBANES-OXLEY ACT OF 2002, AS AMENDED)

Pursuant to 18 U.S.C. Section 1350 (as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, as amended), the undersigned officer of Applied Visual Sciences, Inc., a Delaware corporation (the “Company”), does hereby certify, to such officer’s knowledge, that:

The Quarterly Report on Form 10-Q for the quarter ended June 30, 2015 (the “Report”) of the Company fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (15 U.S.C. 78m or 78o(d), and the information contained in the 10-K fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: August 19, 2015

Signed:

/s/ Gregory E. Hare

Name:

Gregory E. Hare

Title:

Chief Financial Officer

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